Sunday, April 25, 2010

The Policies of the Venn Overlap

Points of agreement between Democrats and Republicans are few. They agree that inflation is bad. And they agree that growth is good. But that's about all they agree on. Yeh, they expect the Federal Reserve to fight inflation and Congress to encourage growth. But what Congress does to encourage growth, and how much, and whether and when, is all beyond the overlap. Likewise whether the Fed should tighten or loosen its grip on money, and how much, and when -- these questions are answered differently on the left and on the right. But these points of disagreement are not the problem.

The points of agreement are the problem.

We came out of World War II with too much money in circulation, and little private-sector debt. The money was causing inflation, and the Federal Reserve fought inflation by tightening its grip. Meanwhile, Congress encouraged growth by cutting taxes and stimulating private spending.

The policies worked. The period from 1947 to 1973 has been called a "golden age of postwar capitalism."

As the years passed, the quantity of money in circulation grew less, relative to GDP, and inflation abated. Meanwhile the economy grew, and the use of credit helped it grow. The original post-war conditions -- too much money in circulation, little debt in the private sector -- gradually changed.

By the 1970s, debt had grown to the point that the use of credit was causing inflation. We were getting inflation because there was too much credit in circulation, and more inflation because of the interest costs embedded in the price of everything. And that's what ended the "golden age."

Then, Reaganomics changed things. It put emphasis on the "supply side." It figured the way to improve growth was to improve conditions for producers and production.

Two things Reaganomics did not change were the points of agreement in the Venn overlap: The expectation that the Federal Reserve should fight inflation, and the expectation that Congress should encourage growth. Our policies continued to reduce the quantity of money in circulation, relative to GDP, and continued to stimulate the growth of private-sector debt.

Those policies worked in the "golden age" because we had little private-sector debt, and too much money. Those policies solved the problems of too much money and too little debt. The problems were solved in the 1960s -- so long ago that today it is difficult to think of them as problems at all.

Those problems were solved in the 1960s, but the policies of the Venn overlap did not change. The policies stopped working in the 1970s because the problems were solved in the '60s. Reducing the quantity of money in circulation is good policy when there is too much money in circulation, but it is bad policy when there is too much credit in circulation. Encouraging the growth of private-sector debt may be good policy when there is little debt, but it is foolhardy when there is already too much.

But no one was willing to change the policies that gave us a "golden age." Even today, we depend on the Federal Reserve to fight inflation by restricting the quantity of money. Still today, Congress does all it can to expand the availability and use of credit.

The policies of the overlap do not work, because the economy changed but the policies didn't. This is the reason we cannot stabilize prices. It is the reason we cannot achieve the growth we expect. And it is the reason we have so much debt.


Jerry said...

Reminds me of the graphs: inflation correlated with the amount of money until the 60s, and inflation correlated with the cost of credit after the 60s.

The Arthurian said...

Ha, well I guess I'm still saying the same thing!

You picked up on my two phrases "money in circulation" and "credit in circulation," and you noticed the difference between 'em. That makes my day.

Ohm (Ώ) said...

Hi Art,

Would you advocate:

1. converting a significant part of Corporate Debt to Equity?

2. Monetising a good part of Public debt, while paying down significant part of the remaining via reduction of many tax deductions to haul in more taxes?

The Arthurian said...

I do not advocate attempts to fix any of the results of the economic policy that encourages reliance on credit. It is the policy itself that must change, and more so the assumptions upon which that policy is based.

I've been working on a post, scheduled for 10 December, that expands on your comment on Winterspeak's post of 25 Sept.


The Arthurian said...

The Points of Agreement Are Never Disputed

At The Guardian, Charles Eisenstein writes:

What we actually need is more spending, say the liberals. No, less spending, say the conservatives. But underneath these disagreements lies an unexamined agreement, a common assumption that no mainstream economist or policy-maker ever questions: that the purpose of economic policy is to stimulate growth.