Janet Yellen Bemoans “Lack of Fiscal Support”

Fed chair Janet Yellen studied under the Keynesian James Tobin, whose name is nowadays best known for being associated with a tax. It should therefore not come as a big surprise that she supports Keynesian dogma regarding government intervention in what is left of the market economy.

As Reuters reports:

“U.S. Federal Reserve Chair Janet Yellen on Friday called on politicians across the globe to get their fiscal houses in order during good times to prop up economies during times of turmoil.

In remarks to a symposium in Paris, Yellen blamed part of the slow global economic recovery on weak government support.

She took aim at both U.S. political gridlock after the 2007-2009 financial crisis and the austere policies across Europe as the region struggles with persistently low inflation.

The crisis led major central banks to deploy unconventional tools to spur recovery. For its part, the Fed cut interest rates to zero and more than quadrupled its balance sheet to $4.4 trillion through three rounds of bond buying, eliciting howls of protest from some politicians who feared the monetary largesse would spark an unwanted inflation. It announced an end to its latest asset purchase program just last week.

While the unconventional tools helped support domestic recovery and global economic growth, more action from fiscal authorities would have strengthened the recovery, Yellen said.

“In the United States, fiscal policy has been much less supportive relative to previous recoveries,” she said during a panel discussion at the Bank of France. Yellen cited data that compared the large increase in U.S. government payrolls after the 2001 recession to the decline of 650,000 government jobs after 2008.

AS central banks seek to promote healthy economies, she said a sharpened focus on financial stability would play a key role. Yellen did not comment on U.S. monetary policy, specifically, but said central banks globally would need to normalize policy as economic activity and inflation return to normal. The timing and speed of policy normalization will vary across countries, Yellen added, and could lead to financial volatility.”

(emphasis added)

(Photo credit: Jim La Scalzo—EPA/Corbis)

So there was “not enough fiscal support” – i.e., deficit spending – in the US since 2008? In some parallel universe perhaps. The US federal government has amassed more debt in the past six years than in its entire history before 2008 (see chart further below).

To the extent that the US economy has recovered, it hasn’t done so because of Federal reserve pumping and deficit spending, but in spite of it. Ms. Yellen’s erroneous beliefs come from the fact that Keynesians are blinded by their models. These models are based on certain assumptions and will therefore always produce a predetermined result that allegedly “proves” these preconceived assumptions. They are a typical case of “garbage in, garbage out”.

It should be obvious that government spending has to be financed to 100% by the private sector. Hence, every cent the government spends is a cent the private sector cannot spend or invest. It matters little whether this is done by taxation or borrowing, the result will be the same. Only if one actually believes that government bureaucrats are better at allocating scarce resources than the free market can one possibly conclude that deficit spending by government is somehow beneficial. This is obviously an absurd contention.

As Ludwig von Mises pointed out:

“At the bottom of the interventionist argument there is always the idea that the government or the state is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes. This is the Santa Claus fable raised by Lord Keynes to the dignity of an economic doctrine and enthusiastically endorsed by all those who expect personal advantage from government spending. As against these popular fallacies there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity.”

(emphasis added)

When the expropriation is effected by inflation – Ms. Yellen’s bailiwick – things are even worse, as then the economy is increasingly “supported” by unsustainable bubble activities based on distortions in relative prices and the falsified economic calculation they inevitably engender.

According to Ms. Yellen, this debt growth was “not enough”

Some time ago, Robert Murphy has discussed the above mentioned “garbage in, garbage out” phenomenon in the context of a model employed by Alan Blinder and Mark Zandi that supposedly “proved” that “stimulus spending creates jobs”. As Mr. Murphy summarizes:

“In the Blinder and Zandi study, the “fact” that real GDP responds positively to government spending is built right into the model. No matter what the data had been — no matter what raw “observations” Blinder and Zandi had plugged in — the model could not possibly have spit out the answer, “The Obama package destroyed 800,000 jobs.” The model assumed that stimulus policies help the economy, and after its whirring the model concluded that — stimulus policies help the economy.”

We highly recommend reading the entire article, which also quotes economist Arnold Kling, who used to work with such models himself (and has become deeply critical of this obvious nonsense).

Are Keynesian Prescriptions Merely Not Properly Implemented?

We often come across remarks that essentially amount to: “but Keynes wasn’t really a Keynesian”, or some variation thereof. These assertions are of the same caliber as the often heard argument that “if only the Soviets had implemented Marxism correctly, everything would have been fine”. See, socialism, really, really works! It is the best system there is, as long as it’s done correctly! The “correct” implementation is of course always that one that precisely follows the personal plan of the respective speaker.

The reality is quite different. Keynes was indeed a Keynesian (just as Marx was really a Marxist…), and his economic analyses and prescriptions have not been “erroneously distorted” by his followers. Rather, his followers were all too often confronted with the fact that his prescriptions simply do not work, and thereupon tried to rescue the whole sorry system by tweaking it.

However, we want to tackle a very specific point here, namely the remark Ms. Yellen reportedly made about “putting fiscal houses in order during good times”. An argument along these lines is quite often forwarded by defenders of Keynes when they are confronted with the fact that Keynesian deficit spending quite obviously fails whenever it is tried – while an ever greater mountain of public debt is most definitely amassed. Japan is a very pertinent example of the utter futility of Keynesian deficit spending (of course, Keynesian models will tell you Japan’s government just didn’t spend enough!).

People then usually proceed to proposing precisely what Ms. Yellen reportedly said by asserting “Keynes recommended running fiscal surpluses in the good times!” Accordingly, so it is held, there would be no perennial public debt growth, and deficit spending would only be deployed in order to “help” the economy when the market economy suffers one of its alleged “failures”.

It is of course never mentioned that the market economy is continually under assault from government intervention and that every boom and bust can ultimately be traced to such intervention. This is also true of the booms and busts that happen on account of private banks engaging in credit expansion from thin air: after all, fractional reserve banking is only possible due to a government privilege. In a free market society based on property rights, a warehouse that holds money the tantundem of which itr has promised to make available on demand, cannot lend this money out behind the backs of its owners without committing fraud.

Below Ludwig von Mises lays out why the counter-cyclical government policies recommended by Ms. Yellen and defenders of Keynesianism are actually quite misguided. This is a lengthy excerpt, but it is well worth assimilating the argument:

As [the interventionist experts] see it, the main thing is “to plan public capital expenditure well in advance and to accumulate a shelf of fully worked out capital projects which can be put into operation at short notice.” This, they say, “is the right policy and one which we recommend all countries should adopt.”

However, the problem is not to elaborate projects, but to provide the material means for their execution. The interventionists believe that this could be easily achieved by holding back government expenditure in the boom and increasing it when the depression comes. Now, restriction of government expenditure may certainly be a good thing. But it does not provide the funds a government needs for a later expansion of its expenditure. An individual may conduct his affairs in this way. He may accumulate savings when his income is high and spend them later when his income drops.

But it is different with a nation or all nations together. The treasury may hoard a considerable part of the lavish revenue from taxes which flows into the public exchequer as a result of the boom. As far and as long as it withholds these funds from circulation, its policy is really deflationary and contra-cyclical and may to this extent weaken the boom created by credit expansion. But when these funds are spent again, they alter the money relation and create a cash-induced tendency toward a drop in the monetary unit’s purchasing power. By no means can these funds provide the capital goods required for the execution of the shelved public works.

The fundamental error of the interventionists consists in the fact that they ignore the shortage of capital goods. In their eyes the depression is merely caused by a mysterious lack of the people’s propensity both to consume and to invest. While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment.

They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill wants the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, the shortage of capital goods.

One could, of course, think of another node for the employment of the savings the government makes in the boom period. The treasury could invest its surplus in buying large stocks of all those materials which it will later, when the depression comes, need for the execution of the public works planned and of the consumers’ goods which those occupied in these public works will ask for. But if the authorities were to act in this way, they would considerably intensify the boom, accelerate the outbreak of the crisis, and make its consequences more serious.”

(emphasis added)

In short, these counter-cyclical policies make no sense whatsoever – things are not made better by producing a “surplus” during the boom that can then be spent during the bust. The fact that the stock of capital goods and other economic resources in the economy does not magically increase on anyone’s mere say-so is the limiting factor to all these plans.

Lastly, Mises concludes that all the talk about counter-cyclical government activities really has only one purpose, namely to pull the wool over our eyes:

All this talk about contra-cyclical government activities aims at one goal only, namely, to divert the public’s attention from cognizance of the real cause of the cyclical fluctuations of business. All governments are firmly committed to the policy of low interest rates, credit expansion, and inflation. When the unavoidable aftermath of these short-term policies appears, they know only of one remedy – to go on in inflationary ventures.

(emphasis added)

Ms. Yellen believes that the injection of approximately $4 trillion in additional money into the US economy by the Federal Reserve has “helped” the economy to return to growth. We say, all that has been achieved is that a distorted bubble economy has been put in place. Once the money supply expansion fall below the threshold required to support assorted bubble activities that have been set into motion, it will swiftly collapse again in another bust.

The ratio of capital vs. consumer goods production: an indicator of the economic distortions wrought by monetary pumping

A direct comparison between production of business equipment, consumer goods and non-durable consumer goods: at the moment the US production structure appears more heavily distorted than ever before 

Conclusion:

As long as policymakers remain wedded to Keynesian nostrums, the era of ever greater booms and busts is set to continue. Hopefully there will still be a market economy left when we at last arrive at the end of the road.