I just read two of the dumbest ideas ever about how to fix the economy by two academic economists, one from UCLA, the other from Harvard, in respected publications.
In a much discussed article in The New York Times a few weeks ago (“It May Be Time for the Fed to Go Negative”), Harvard Economics Professor Gregory Mankiw, a former adviser to President Bush, suggested that the Fed create negative real interest rates by “committing to inflation” in order to stimulate the economy:
If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.
Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.
Really this is so dumb, and scary, as to make me question whether this isn’t some kind of joke. Obviously, the good Professor has no idea what hyperinflation can do to a society. If he thinks the problems we have now are bad, I suggest he take a look at what happened in Germany in the 1920s when they had hyperinflation.
When you destroy the currency, you make it impossible for people to trade via money. When people can’t trade via money, the entire division of labor, civilization itself, breaks down and you have anarchy and a state of nature among men. Trust me when I say what we are going through right now is NOTHING compared to what would result if inflation got out of control and people lost confidence in the dollar.
In the second piece from BusinessWeek (“Macroeconomics: Adjusting the Big Picture”), UCLA Economist Roger Farmer suggests the Fed make large scale stock purchases to get the economy back on track:
The answer, in Farmer’s view, is for the Fed to set a target for how high it wants the stock market to be by a certain date, then commit to buying enough shares (through broad-based index funds) to hit that target. Higher stock prices will make people feel wealthier and spend more, creating prosperity. Symmetrically, he would have the Fed sell to hold down prices in boom times.
Again, is this a serious, responsible thing to say? The value of a stock is supposed to be set on a public market between buyers and sellers which results in a price that should hopefully bear some relation to the company’s intrinsic value. Farmer is recommending manipulating the value of stocks, irrespective of their fundamentals, in order to create an illusion of wealth. This illusion is then supposed to be the foundation of economic progress and prosperity. Isn’t that a pretty good description of our economy during the housing bubble? How’d that work out for us?
Did Farmer ever consider that real economic progress can’t be financially engineered but depends on increased productivity, innovation and technology in the real economy? It’s these latter things, obviously, and not government manipulation and financial engineering that increase our capacity to produce and therefore our standard of living.
On the failure of academic economists, also see my “Academic Economists Reckon With Their Cluelessness”, Top Gun FP, January 12, 2009.