Sunday, December 21, 2008

The wrong direction

Many people talked about a housing "bubble" before it "popped", but none (to my knowledge) warned about the credit and economic contraction that would follow. Nevertheless, no one is shy about being wise enough to offer radical policy prescriptions now that the downturn is here.

In Crisis and Leviathan: Critical Episodes in the Growth of American Government, Robert Higgs document how crises always expand the scope and size of government. And enlarged scope and size remain after the crisis has passed. He called attention to ratchet effects.

Bob has also written about the regime uncertainty that came with the New Deal. Radical rule changes that threatened property rights caused investors to withdraw. This is why there never was a recovery through the 1930s. The Keynsian promise never materialized. In fact, New Deal policies were the poison.

Neither was there a Keynsian recovery during WW II. War time unemployment may have been down but there was conscription. As Higgs puts it, putting people in prison would have had the same effect on the stats. War time GDP data are also suspect. There were no market prices!

Prosperity did not return until the post-war years. By this time the radicals that had surrounded FDR in the late 1930s were long gone; they had been replaced by business people who were brought into government as part of the war effort. Confidence and prosperity returned after the war.

Bob Higgs explains all this on econtalk. Unlike the conventional wisdom, his model explains the 1930s as well as the 1940s.

Where are we now? Gearing up to do all the wrong things -- including embracing massive Keynsian stimulus plus massive regime uncertainty. Polticians from both parties have been signaling ad hoccery for months.

There have always been business cycles. They usually end via workout when assets are re-priced and entreprneurial confidence returns and discovery efforts are again incited. Policy makers with only a clear commitment to printing boatloads of dollars push in exactly the wrong direction. Why would anyone bid on any distressed asset when there is a TARP (and perhaps son of TARP) in the wings?