Out of cauldrons sometimes life can be born. This is what is often said of the primordial soup that produced the DNA millions of years ago. As one-half of the global economy split between the United States and the European Union is trying to figure out how to avoid breadlines and soup kitchens, the metaphor of primordial soup could in fact be uplifting to think about breathing life into a moribund economy.
The current crisis has been compared to the Great Depression perhaps expecting political dysfunction and the incapacity of the spineless economics profession to together make matters worse while pretending to make them better. It may be time to really make them better by dropping the pretense. The cauldron of the Great Depression had revolutionized economics. It produced a systematic framework to think about the macroeconomy guided by an equally revolutionary political ideology to expand the role of the government in countries, including the United States, which were until then largely laissez-faire.
In the anticipation of the next Great Depression, for as long as it has been anticipated, perhaps its realization is not necessary to change because the target of that forecast must be its prevention at a minimum, if not reform for robust recovery. The point of the state of paralysis in Washington at the moment instead seems to be to shove the true depth of the problem under the rug to manipulate expectations to prevent a rush by the consumers to the exits sooner than later rather than to reform appropriately to genuinely improve expectations.
The ideology governing that masquerade is the same ideology that made Keynesianism the handmaiden of every president since FDR all the way up to Ronald Reagan. And now it has become Obama’s ghost with the political purpose of reversing Reagan. The political-economic struggle to prop up Keynesianism has lost sight of its purpose in the emerging grand irony of economic history.
The economics of Keynesianism is not the politics of big government. It is about understanding how an economy works, in aggregate. After the Great Depression there was no reason for FDR to expand government if only the government could better direct private capital toward its more gainful uses to recover the economy. FDR’s regulatory apparatus could have complemented Fed’s monetary expansion, instead of the two successive contractions that raised the government debt to expand government rather than to send the Fed’s money where it was needed.
This same mistake is being made again. The Bernanke Fed did not want to contract money supply in the face of the overleveraged and imploding financial markets. Not to repeat the supposed mistakes made by the Eccles Fed from 1933 through 1937, the Bernanke Fed focused on expanding money supply using all means necessary, throwing aside any concerns about how it was doing so, which is the cause of the current dissatisfaction with the institution.
But the government, in the period 2007 through 2008, was in the mood not to worry about regulation and the government since 2009 is in the mood to reregulate. Neither government was and is of the mindset to regulate appropriately. The money, albeit in expansionary mode, has still not gone to where it needs to go: toward raising real investment and creating jobs to raise wages, reducing debt and to increase national savings; hence, the current economic predicament. The mistake is being repeated because its true cause was not understood.
That persistent government spending in the Keynesian output equation, whether that was gradually transmitted through civilian projects or immediately though the war effort, recovered the U.S economy eventually self-sustainably does not necessarily make government spending always the engine of economic growth and recovery. Money supply can do the same, directly rather than through the circuitous route of increasing government debt and deficits. But monetarist Keynesianism has not been tried yet because of the pro-government political ideology that tied monetary policy making to government debt.
Monetarism was the way of the world before 1913 and Keynesianism has become the way of the world after 1945. The intervening time of transition produced two world wars. Bill Clinton wanted to make it Keynesian monetarism. What the world needs is monetarist Keynesianism: an interventionist central bank and a less interventionist fiscal policy to achieve economic policy independence from political manipulation, not from political accountability. It is not the economy, stupid. This is the world that can be the silver lining to the dark economic clouds that have been gathering since 2007.
The case of the failure of the U.S financial markets and that of their aid to Greece to circumvent euro area borrowing rules to expand government profligacy points to a bright future, not a dismal one. It demonstrates the capacity of the financial markets to create a diversity of financial instruments which can be traded by the central banks of countries instead of their finance ministries to ensure the quality of money supply.
The central banks, as necessary, prod the markets without the need for separate infrastructure and other government investment banks as in Europe to shift the markets where its money could be best utilized by changing their balance sheet portfolios containing the various types of financial instruments they want to buy and sell in exchange for cash. Ensuring the quality of those instruments would be a function of monetary operations, not financial regulation. Government bonds would simply be one component of such a central bank portfolio, not its basis.
The government would still be issuing its debt, but constrained by fiscal rules as in the euro area to meet its obligations to the citizens. And an explicit inflation targeting range will keep the central banks honest and accountable, while their policy transparency pertaining to their economic forecasts and monetary policy decisions will keep them less closeted and less secretive. The fact that government bonds are only a variable part of the portfolio of the central bank, gives the central banks the freedom to manage government debt through monetary policy.
The Federal Reserve, as an example, would then be the government equivalent of a financial holding company (FHC but without outsourcing that financial management to Blackrock and the like) (with some recent experience under its belt having accumulated significant private securities on its balance sheet), but with the objective function of its mandate unlike a private sector financial holding company. All other financial sector regulation and payments systems must still be divested from the Fed to the Treasury and consumer protection functions to the Federal Trade Commission (FTC) to avoid conflict of interest, with both the Fed and the Treasury jointly accountable to the Congress. This structure and policy operations for monetary policy will help better direct private capital flows around the world, to avoid debacles such as Greece. Such a structure can also intrinsically bring global financial stability within the purview of the International Monetary Fund (IMF) under its current mandate.