Sunday, May 31, 2009
Recession/Credit Crisis or Social Engineering?
Tax Increases on Consumers and Businesses.
Is the laundry list of tax increases proposed by the Obama Administration, while the economy is in a deep recession, sound economic policy?.
If you look at the many empirical economic studies of the Great Depression one reoccurring finding is that tax increases during the Depression reversed/dampened any positive effects of Keynesian Deficit Government Spending.
Its clear in the Theory of Keynesian Deficit Government Spending that the spending is intended to be temporary until the Private Sector rebounds. The Private Sector needs Private Capital Formation to rebound.
However, the list of tax increases proposed by the Obama Administration is so long, affecting so many sectors, affecting both consumers and business, that the varying and several tax increases are going to create a tax increase multiplier effect cascading within the Private Sector. Add in State Government tax increases and the multiplier effect is further magnified.
The effect of the Tax Increase Multiplier will be that Capital Formation as well as consumer and business consumption will be decreasing at an increasing rate.
Keynesian Deficit Government Spending and Quantitative Easing
Keynesian Deficit Government Spending during the Depression was in an environment of zero or low current Government Debt. Current Keynesian Deficit Spending is occurring in an environment of high current and future Government Debt. Moreover, Keynesian Deficit Government Spending as well as Quantitative Easing were theories developed in an environment of zero or low government debt as well as significant deflation. That the current deployment of Quantitative Easing is occurring in an environment of small, moderate or even zero deflation. Finally, Keynesian Government Spending and Quantitative Easing are being deployed simultaneously. The only time Quantitative Easing and Keynesian Deficit Government Spending have been simultaneously deployed in a Modern Economy was 2001-2006 in Japan. Japan continues to this day in a 20 year long recession (1989 to present).
Economic Train Wrecks and Unintended Consequences
Countervailing Economic Policies create unintended consequences. Quantitative Easing is creating a less valuable US Dollar hence creating upward pressure on US Government Debt in two areas: the quality of the debt is being downgraded causing the perceived risk to increase hence causing the interest rate on the debt to increase. Further, Quantitative Easing is causing the specter of inflation to raise its ugly head as the money supply has increased by nearly 700 Billion Dollars since 10/2008 as measured by M2.
Meanwhile, Keynesian Deficit Government Spending has been deployed nearly simultaneously with Quantitative Easing. US Government Debt is increasing at an increasing rate. The current US Government Debt was high before the Enactment of the $800 Billion Dollar Stimulus Package. Add to the Stimulus Package a massive current Budget Spending Plan, and debt is increasing at an increasing rate. Hence the economic phenomena of increasing debt at an increasing rate is affecting the Value of US Government Debt as well as interest rates associated with the debt.
One of the Unintended Consequences of simultaneously deploying Quantitative Easing and Keynesian Deficit Government Spending in an environment of high current debt and debt increasing at an increasing rate is that the debt is downgraded and interest rates move upward.
Moreover, the proposed laundry list of consumer and business tax increases will cause households and business to have less disposable income. Further, business tax increases depress Private Capital Formation. Hence the deployment of Keynesian Deficit Government Spending to stimulate the economy is counter acted by the laundry list of tax increases. That is, Demand is increased by Deficit Government Spending and Demand is decreased by tax increases. Also, the tax increases depress Private Capital Formation that in the Theory of Keynesian Economics is suppose to create jobs when the stimulus money runs out.
Add to the above countervailing forces and unintended consequences the cost of a Social Engineering agenda on par with Lyndon Johnson's Great Society, and you add Government Debt that becomes unsustainable.
Pick and Choose
Basically you have Recession/Credit Crisis or you have Social Engineering Program. The US Economy can barely afford one option but not both options. Attempting to initiate Great Society Entitlement Programs while in the mist of a Recession/Credit Crisis is a recipe for Economic disaster.
If you pick the Political Economy of fixing the Recession/Credit Crisis, once the problem is solved you will not be able to initiate the Social Engineering programs as the current entitlements (Social Security, Medicare, Medicaid, etc.) are overbearing as they stand now. One would need to address the current financing of the current entitlements.
If you pick the Political Economy of Social Engineering (expanding entitlements) you end up with an economy in Stagflation with a debt burden increasing at an increasing rate.