This is my first blog. Blogging has been around for at least 7-8 years, so I didn't start this now because it is the "in" thing to do (That would be hanging out on Google +!). The reason I started this is because I feel very strongly about the topic I write about here. I just don't complain, I have a solution and I am looking for scenarios in which my solution might break.
People familiar with Keynesian economics know that John Maynard Keynes advocated the seemingly counter intuitive policy which states " Governments should spend money they don't have to save capitalism.". This fiscal policy was widely adopted by Governments around the world post-Great Depression as a way to get back to more "normal growth" and "normal unemployment". Supporters of Keynes policy claim the growth in economies around the world Post World War II was mainly because of Keynesian policies adopted after the Great Depression.
Post 1970's though, a new "old" school of thought emerged as a response to sluggish growth in economies around the world. Keynesian spending had left governments around the growth servicing greater debt burdens than ever, as a result policymakers chose to raise tax rates as a means of raising government revenue to service these debts. Some thought, these high tax rates (supposedly reaching 90% in some instances), took away the incentive of the most productive in society to produce and thus caused the sluggish growth. Keynesian economics was discarded then in the western world as "Tax and Spend Economics" at best and "Socialism" at worst.
Ayn Rand, Milton Friedman and the likes of Alan Greenspan, argued that the "only way" to achieve prosperity for all was to allow laissez-faire economics. (Ref Wikipedia : In economics, laissez-faire (English pronunciation: /ˌlɛseɪˈfɛər/ (
listen), French: [lesefɛʁ] ( listen)) describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies.) While in theory this sounded great and new, actually it was the same old classical economics proposed by Adam Smith (in his "invisible hand" hypothesis) and others.
This new "old" economics was all the rage in the 1980's. Art Laffer ( of the "Laffer Curve" fame) correctly postulated that tax revenue would be zero if tax rates were 0% and 100%. So there was an optimal tax rate between 0% and 100% where government could raise maximum revenue. This was the founding principle for "Reaganomics" in the 80's and 90's. The idea that lower tax rates would provide the incentive to invest or spend, which in turn would drive productive activity higher, leading to higher GDP and thus potentially a higher net tax revenue.
Thus Governments around the world reduced taxes which did produce tax revenue growth to some extent, but politicians being politicians, spent a lot more than the revenue they took in. After all it was easier getting elected if you promised your constituents new spending programs in addition to lower taxes. However low tax rates seemingly caused the most productive (or rich) in the society to benefit more and thus increased income disparity. Politicians and Policymakers countered that with regulations to "help the poor". Which lead to policies like advocating increased home ownership, tax deductions for homeowners etc. Collective stupidity took over and the world saw a series of booms and busts.
In present day economics, politicians and policy makers are torn between the two choices they have. Should they re-instate some common sense regulation and continue with "Free Market Capitalism" or should they revert back to Keynesian model of government spending to foster growth followed by increased taxation to service the debt. In my honest opinion the American economy currently has one leg in each choice, unable to decide the course of action and that is why we have markets see-sawing, economy growing and thawing but keeping unemployment unreasonably high.
I think Keynes was right. Government needs to spend money it doesn't have.
I think Friedman was right. I think Laffer is right. Taxes should go down.
How on earth can I rationalize these seemingly contradicting policy scenarios?
It is quite simple. When Keynes said government needs to spend money it doesn't have to save capitalism, he never meant raise taxes to fund spending. Friedman always proposed a low flat tax rate not a progressively lower tax structure. Art Laffer never said what the optimal tax rate it, in fact the optimal tax rate even if it exists might not be a constant number, it could change with time and economic conditions.
This is where I attempt to re-interpret their theories collectively. Government can print money to fund the various spending programs it can conceive of. A 0% tax rate satisfies Friedman's condition of low tax rate as well as Art Laffer's hypothesis of optimal revenue when that optimal revenue is 0. Why does the government need to take money from productive people of society to fund their pet projects when it has the seemingly unlimited capacity to print money. It doesn't make any sense to appear to punish people for their productivity.
Well, one might ask, wouldn't printing money cause inflation?
Sure it does.
How can that be helpful economically?
Inflation is the real flat and optimal tax rate we all need. No politician, policymaker or Harvard educated economist can ever set it. It changes with time and with economic conditions. Sure politicians can run the printing press overtime and cause hyper inflation, but that will surely cause the populace to take notice and given a democracy, it wouldn't take much to replace them with more conservative ones.
Doesn't inflation hurt savers disproportionately?
Sure it does. But it only hurts savers of cash. If you invested in real assets like gold, certain commodities, houses or even companies, inflation might not matter to you as your asset value will still grow at the pace of real growth. For example in a country with static population and limited number of houses in economic equilibrium, if there is inflation of 10%, you can be sure that house prices will also increase by 10%. Now if suddenly the population decreases or everyone decided to build more houses, then house prices might fall, as they should. The point is Free Market Capitalism or Economics 101 says Supply Demand should be the only driver of prices and nothing else.
How does inflation help our current economic morass?
The problem we have now is, people who have money are not investing or spending because they know inflation is low or are afraid we are in deflationary spiral. People who don't have money have a debt burden which is their primary focus and they will not spend until that reduces to some acceptable level. We know GDP is composed of consumer spending, government spending, net exports and capital investment. If consumer spending and capital investments are non-starters because of reasons above and net exports are primarily driven by overseas demand for our products and our demand for theirs, the only choice we are left with is government spending. The only way to finance it is via current or future taxation if inflation is supposed to be stable. Both alternatives caused lesser consumer spending and lesser investment as high taxation is a strong disincentive to spend or invest.
Alternatively, if we print money and spend, thus causing inflation, consumers who know prices will increase tommorow would be rationally convinced to buy today. Savers who are hoarding cash assets will be rationally convinced to invest in real assets now or in other words promote capital investment. Inflation also causes the future value of debt to reduce, thus providing an added incentive for consumers to spend now thus making the de-leveraging process appear less painful to all.
Isn't Inflation slow default on our creditors and wouldn't it cause interest rates to go up?
Inflation is definitely slow default. Our creditors would rationally charge us more in interest to pay for the inflation. But this high interest rate would naturally reduce inflation as evidenced by our monetary policy experiments in the last century. High interest rates might reduce the money supply and slowly bring down inflation as long as we print money at a rate lower than the increase in interest rates. If that doesn't happen, then yes creditors lose money and it might not be such a bad thing.
Let me know what you think. I would be happy to see someone identify holes in my argument, but would be more happy to see someone come up with a better solution to past and present economic problems around the globe.
Thanks for patiently reading my first blog!
Here we go ...
People familiar with Keynesian economics know that John Maynard Keynes advocated the seemingly counter intuitive policy which states " Governments should spend money they don't have to save capitalism.". This fiscal policy was widely adopted by Governments around the world post-Great Depression as a way to get back to more "normal growth" and "normal unemployment". Supporters of Keynes policy claim the growth in economies around the world Post World War II was mainly because of Keynesian policies adopted after the Great Depression.
Post 1970's though, a new "old" school of thought emerged as a response to sluggish growth in economies around the world. Keynesian spending had left governments around the growth servicing greater debt burdens than ever, as a result policymakers chose to raise tax rates as a means of raising government revenue to service these debts. Some thought, these high tax rates (supposedly reaching 90% in some instances), took away the incentive of the most productive in society to produce and thus caused the sluggish growth. Keynesian economics was discarded then in the western world as "Tax and Spend Economics" at best and "Socialism" at worst.
Ayn Rand, Milton Friedman and the likes of Alan Greenspan, argued that the "only way" to achieve prosperity for all was to allow laissez-faire economics. (Ref Wikipedia : In economics, laissez-faire (English pronunciation: /ˌlɛseɪˈfɛər/ (
listen), French: [lesefɛʁ] ( listen)) describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies.) While in theory this sounded great and new, actually it was the same old classical economics proposed by Adam Smith (in his "invisible hand" hypothesis) and others.This new "old" economics was all the rage in the 1980's. Art Laffer ( of the "Laffer Curve" fame) correctly postulated that tax revenue would be zero if tax rates were 0% and 100%. So there was an optimal tax rate between 0% and 100% where government could raise maximum revenue. This was the founding principle for "Reaganomics" in the 80's and 90's. The idea that lower tax rates would provide the incentive to invest or spend, which in turn would drive productive activity higher, leading to higher GDP and thus potentially a higher net tax revenue.
Thus Governments around the world reduced taxes which did produce tax revenue growth to some extent, but politicians being politicians, spent a lot more than the revenue they took in. After all it was easier getting elected if you promised your constituents new spending programs in addition to lower taxes. However low tax rates seemingly caused the most productive (or rich) in the society to benefit more and thus increased income disparity. Politicians and Policymakers countered that with regulations to "help the poor". Which lead to policies like advocating increased home ownership, tax deductions for homeowners etc. Collective stupidity took over and the world saw a series of booms and busts.
In present day economics, politicians and policy makers are torn between the two choices they have. Should they re-instate some common sense regulation and continue with "Free Market Capitalism" or should they revert back to Keynesian model of government spending to foster growth followed by increased taxation to service the debt. In my honest opinion the American economy currently has one leg in each choice, unable to decide the course of action and that is why we have markets see-sawing, economy growing and thawing but keeping unemployment unreasonably high.
I think Keynes was right. Government needs to spend money it doesn't have.
I think Friedman was right. I think Laffer is right. Taxes should go down.
How on earth can I rationalize these seemingly contradicting policy scenarios?
It is quite simple. When Keynes said government needs to spend money it doesn't have to save capitalism, he never meant raise taxes to fund spending. Friedman always proposed a low flat tax rate not a progressively lower tax structure. Art Laffer never said what the optimal tax rate it, in fact the optimal tax rate even if it exists might not be a constant number, it could change with time and economic conditions.
This is where I attempt to re-interpret their theories collectively. Government can print money to fund the various spending programs it can conceive of. A 0% tax rate satisfies Friedman's condition of low tax rate as well as Art Laffer's hypothesis of optimal revenue when that optimal revenue is 0. Why does the government need to take money from productive people of society to fund their pet projects when it has the seemingly unlimited capacity to print money. It doesn't make any sense to appear to punish people for their productivity.
Well, one might ask, wouldn't printing money cause inflation?
Sure it does.
How can that be helpful economically?
Inflation is the real flat and optimal tax rate we all need. No politician, policymaker or Harvard educated economist can ever set it. It changes with time and with economic conditions. Sure politicians can run the printing press overtime and cause hyper inflation, but that will surely cause the populace to take notice and given a democracy, it wouldn't take much to replace them with more conservative ones.
Doesn't inflation hurt savers disproportionately?
Sure it does. But it only hurts savers of cash. If you invested in real assets like gold, certain commodities, houses or even companies, inflation might not matter to you as your asset value will still grow at the pace of real growth. For example in a country with static population and limited number of houses in economic equilibrium, if there is inflation of 10%, you can be sure that house prices will also increase by 10%. Now if suddenly the population decreases or everyone decided to build more houses, then house prices might fall, as they should. The point is Free Market Capitalism or Economics 101 says Supply Demand should be the only driver of prices and nothing else.
How does inflation help our current economic morass?
The problem we have now is, people who have money are not investing or spending because they know inflation is low or are afraid we are in deflationary spiral. People who don't have money have a debt burden which is their primary focus and they will not spend until that reduces to some acceptable level. We know GDP is composed of consumer spending, government spending, net exports and capital investment. If consumer spending and capital investments are non-starters because of reasons above and net exports are primarily driven by overseas demand for our products and our demand for theirs, the only choice we are left with is government spending. The only way to finance it is via current or future taxation if inflation is supposed to be stable. Both alternatives caused lesser consumer spending and lesser investment as high taxation is a strong disincentive to spend or invest.
Alternatively, if we print money and spend, thus causing inflation, consumers who know prices will increase tommorow would be rationally convinced to buy today. Savers who are hoarding cash assets will be rationally convinced to invest in real assets now or in other words promote capital investment. Inflation also causes the future value of debt to reduce, thus providing an added incentive for consumers to spend now thus making the de-leveraging process appear less painful to all.
Isn't Inflation slow default on our creditors and wouldn't it cause interest rates to go up?
Inflation is definitely slow default. Our creditors would rationally charge us more in interest to pay for the inflation. But this high interest rate would naturally reduce inflation as evidenced by our monetary policy experiments in the last century. High interest rates might reduce the money supply and slowly bring down inflation as long as we print money at a rate lower than the increase in interest rates. If that doesn't happen, then yes creditors lose money and it might not be such a bad thing.
My overall argument here is, we need less of creditors and more of investors. Inflationary policy accomplishes both as creditors will be less willing to lend , given the slow default and investors will be more willing to invest and take the risk given the reducing value of cash in hand. We definitely don't need "official" taxes, as demonstrated above, they only add an additional layer of inefficiency to the system. Inflation is a real, fair, flat tax in itself.
Let me know what you think. I would be happy to see someone identify holes in my argument, but would be more happy to see someone come up with a better solution to past and present economic problems around the globe.
Thanks for patiently reading my first blog!
