Palin’ around with "liquidate, liquidate, liquidate"
In his famous (or infamous) advice to Herbert Hoover, Secretary of Treasury Andrew Mellon provided the following policy advice to Herbert Hoover as to how to deal with the Great Depression:
"liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate... it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
This policy advice is now implicitly what Sarah Palin is urging in her most recent criticism of Fed Chair’s Ben Bernanke’s strategy of quantitative easing which we might dub "liquidity, liquidity, liquidity". Below the fold I attempt to explain what has to be so if there is any rational way at all to understand Palin’s decision to issue a cease and desist order to Fed Chair Ben Bernanke. Whether or not Palin understands that her argument undermines itself, or whether she wrote her facebook tweet herself or had someone write it for her, are separate questions.
The first argument that Palin makes, I have to admit frankly, almost, potentially makes sense. Palin begins, not by channeling Keynes per se, but by almost channeling the so called Keynesian textbooks of the 1970’s and 1980’s.
In her facebook tweet Palin begins with an almost, coherent, rational argument:
..."the reason banks aren’t lending and businesses aren’t investing isn’t because of insufficient access to credit. There’s plenty of money around, it’s just that no one’s willing to spend it. Big businesses especially have been hoarding cash."
So far, not so bad-and I might add, actually and quite surprisingly almost captures my own uneasiness about quantitative easing. But first, a brief primer on what "quantitative easing" means (at the risk of being simplistic I’ll put this in the terms of a basic, mainstream, macro textbook). In a fractional reserve system such as ours, the amount of money in the system is cash and bank deposits. But let’s not complicate our discussion about money with cash-let’s focus instead just on bank deposits. These bank deposits are a multiple of reserves. Historically, a $1 change in reserves leads to almost a $2 change in bank deposits-or in other words, the quantity of money. By buying bonds from banks, the FED will give banks reserves (base money to put it simplistically), thus allowing them to make more loans, which create more deposits, which allows more loans, which creates more deposits, etc. Is the FED "printing money"? Maybe.
Here is where the discussion gets tricky. What happens if banks actually have lots of reserves and could be making more loans? Then giving them more reserves won’t actually translate into more lending. And this lack of lending obviously won't translate into more borrowing and more investment spending, and therefore, does not result in inflation. We are already in the language of the principles textbooks of the 70’s and 80’s in a liquidity trap. As the old adage goes-you can pull on a string but you can’t push on it.
No sooner does Palin **almost** make a rational argument, that she then undermines it. The problem, according to Palin, is not that consumers don’t want to buy products because they lack jobs. The problem, according to Palin, is that Obama’s "big spending" (which is actually non-existent) has created "uncertainty" for business, and therefore, businesses won’t borrow and banks won’t lend. This ignores of course the obvious counter-argument: the financial crisis and the resultant collapse in aggregate demand and housing prices have created an environment in which future sales are uncertain. Of course, for Palin to acknowledge that means that she must recognize that the Great Recession started as a financial crisis which occurred while Obama was a candidate. Hence Palin can avoid facing the responsibility of Republican policies (and democratic support for those policies) as the explanation for the current malaise.
The second part of Palin’s argument-that Obama’s policies will cause inflation-but not create growth-can only be true under two circumstances. Those circumstances are what we economists call the quantity theory of money is true (any increase in the quantity of money results in a predictable increase in output, unadjusted for inflation). But in order for this to be remotely true, the economy must be at or near, something we can reasonably call full employment. Even Milton Friedman argued that the correct response to a collapse in aggregate demand is quantitative easing. In contrast, the Keynesians argued that the correct response is quantitative easing **and** expansionary fiscal policy. To sum up-if quantitative easing is effective, it will indeed raise the current rate of inflation from its current very low rate of about 1%, to a higher rate-perhaps 3-4%.
Here we get to what it is I doubt Palin understands, but what the defunct economists she is parroting no doubt do. In essence, Palin is arguing that 9.5% unemployment and 1% inflation is just fine with her. The reality is that an increase in spending and output will indeed put upward pressure on inflation.
What is Palin’s solution:
"If the President was serious about getting the economy moving again, he’d stop supporting the Fed’s dangerous experiments with our currency and focus instead on what actually works: reducing government spending and boosting business investment through good old fashioned supply side reforms (cutting taxes and reducing overly burdensome regulations). "
Leaving aside that Bernanke was appointed by a Republican President, and that even Republican oriented economists like Gregg Mankiw-if they are consistent-will support quantitative easing, Palin is now simply wandering off into an incoherent argument. Palin believes that reducing government spending (in other words, cutting social security, cutting off unemployment benefits, refusing to expand liquidity) will all magically make it easier to create jobs. And she also believes that cutting taxes is the path to reducing deficits. While it is true, that under some circumstances, a one dollar cut in taxes (just like a one dollar increase-that’s right-increase-in government spending) will give us more than a one dollar increase in output, it is simply not true that a one dollar cut in taxes will yield more than one dollar in increased tax revenue. The very, very best that Palin’s solution could result in is no change in aggregate spending at all. And this ignores the uncertainty that will result from starving infrastructure, laying off teachers, cutting social security benefits and the long run damage to the nation’s capacity to grow from the same.
What then is Palin’s solution. There is only one rational way to interpret it. She believes that what we must do is "liquidate, liquidate, liquidate." As Keynes once said (paraphrasing) the advocates of "liquidate, liquidate" need to explain what jobs they think should not have been created and what factories should not have been built. And this also raises the question as to why it is the working people of this country who should be asked to "liquidate", but not Wall Street financiers.
Does Palin understand what she is advocating? There is a part of me that sincerely doubts it. There is also a part of me that thinks it is irrelevant. Whether Palin really is the typical D+ student, simply parroting the wisdom of defunct economists someone whispers in her air, or whether she can actually explain what she says doesn’t matter one wit. What does matter is that we are being sold a package of snake oil and yet, no one has been able to call the Republicans out for advocating a strategy of "liquidate, liquidate, liquidate".
Whether or not the strategy of "liquidity, liquidity, liquidity" can work remains to be seen. If it does indeed create inflation, that may well be a good thing, because that will mean that aggregate demand and spending and output and employment have all increased. The best, the correct policy right now is actually 900 billion in real fiscal stimulus. There is no evidence right now that we have an excess demand for money. My best guess is that quantitative easing won’t work, and because it won’t work, it won’t create inflation.
Having said all that I'd much prefer "liquidity, liquidity, liquidity" to "liquidate, liquidate, liquidate" just as surely as I would rather have a full bottle in front of me, than a full frontal lobotomy.