Amar Bhide on Fearmongering and the Economy

In the Wall Street Journal Professor Amar Bhide writes,

Our ignorance of what causes economic ailments — and how to treat them — is profound. Downturns and financial crises are not regular occurrences, and because economies are always evolving, they tend to be idiosyncratic, singular events.

After decades of diligent research, scholars still argue about what caused the Great Depression — excessive consumption, investment, stock-market speculation and borrowing in the Roaring ’20s, Smoot-Hawley protectionism, or excessively tight monetary policy? Nor do we know how we got out of it: Some credit the New Deal while others say that that FDR’s policies prolonged the Depression.

Similarly, there is no consensus about why huge public-spending projects and a zero-interest-rate policy failed to pull the Japanese out of a prolonged slump.

The economic theory behind the nearly $800 billion stimulus package may be cloaked in precise mathematics but is ultimately based on John Maynard Keynes’s speculative conjecture about human nature. Keynes claimed that people cope with uncertainty by assuming the future will be like the present. This predisposition exacerbates economic downturns and should be countered by a sharp fiscal stimulus that reignites the “animal spirits” of consumers and investors.

But history suggests that dark moods do change on their own. The depressions and panics of the 19th century ended without any fiscal stimulus to speak of, as did the gloom that followed the stock-market crash of 1987. Countercyclical fiscal policy may or may not have shortened other recessions; there are too few data points and too much difference in other conditions to really know.

Unfounded assertions that calamitous consequences make opposition to the rapid enactment of a large stimulus package “inexcusable and irresponsible” are likely to offset any placebo effect the package might have. Shouting “fire” in a crowded theater, as our last Treasury secretary did to peddle the Troubled Asset Relief Program (TARP), didn’t restore financial confidence. Similarly, a president elected on a platform of hope isn’t likely to spark shopping sprees by painting a bleak picture of our prospects.

Not only that, but I think the “jolt the economy”, “jump start the economy” etc. type of rhetoric is misleading as well. For example, the CBO’s analysis shows that even in the best of cases the stimulus will make a bad situation a little bit less worse, not good, great, or even acceptable. This is typical politico speak we are getting from Obama. Exaggerate the current state, and exaggerate the potential effects of his policy prescription.

Large increases in public spending usurp precious resources from supporting the innovations necessary for our long-term prosperity. Everyone isn’t a pessimist in hard times: The optimism of many entrepreneurs and consumers fueled the takeoff of personal computers during the deep recession of the early 1980s. Amazon has just launched the Kindle 2; its (equally pricey) predecessor sold out last November amid the Wall Street meltdown. But competing with expanded public spending makes it harder for innovations like the personal computer and the Kindle to secure the resources they need.

This is the crowding out effect. It is something that can reduce economic growth in the future. Further, our fiscal situation was bad even before George W. Bush. Sure we had a few trillion in surplus, but we also have a huge problem with Medicare and a somewhat smaller problem with Social Security. Factor in the much, much higher budget deficits and that taxes will likely have to be higher in the future adding on even more right now and in ways that are doubtful to help long term growth and productivity could reduce future economic growth. Further, this stimulus is unlikely to have much impact on the financial sector (more on this in another post hopefully).

Hastily enacted programs jeopardize crucial beliefs in the value of productive enterprise. Americans are unusually idealistic and optimistic.


To sustain these beliefs, Americans must see their government play the role of an even-handed referee rather than be a dispenser of rewards or even a judge of economic merit or contribution. The panicky response to the financial crisis, where openness and due process have been sacrificed to speed, has unfortunately undermined our faith. Bailing out AIG while letting Lehman fail — behind closed doors — has raised suspicions of cronyism. The Fed has refused to reveal to whom it has lent trillions. Outrage at the perceived use of TARP funds to pay bonuses is widespread.

The Obama administration assures us that it will only fund “worthwhile” and “shovel-ready” projects. But choices will have to be made by harried and fallible humans; witness the nominees who failed to calculate their taxes properly. What’s more, subjecting projects to scrutiny conflicts with a strategy of sparking the economy with a jolt of new spending. We may get the worst of all worlds — savvy and well-connected operators get funding while good projects languish.

Yes, rent seeking is always a problem and it could limit whatever benefits the stimulus spending could bring about. After all these decisions are made by politicians and what do politicians worry about above all other things? Getting re-elected. For this they need money and that means contributions. And the best of all words are contributions from groups living in their own district.

The alternative isn’t, as the stimulus scaremongers suggest, to turn our backs to the downturn. We do have mechanisms in place to deal with economic distress. Public aid for the indigent has been modernized and expanded to provide a range of unemployment and income-maintenance schemes. Bankruptcy courts and laws give individuals another chance and facilitate the orderly reorganization or liquidation of troubled businesses. The FDIC has been dealing with bank failures for more than 70 years, and the Federal Reserve has been empowered to provide liquidity in the face of financial panics for even longer.

Quite right, the “do nothing” approach isn’t really doing nothing as these institutions will come into play. The Federal Reserve has already injected trillions into the economy and worked to keep various financial institutions from failing. The FDIC has taken over banks and guaranteed deposits and the amount that is covered has been increased as well. There are potential problems in that some acounts do have very large sums in them, but even here I think it could be possible to guarantee those deposits as well. Maybe this isn’t enough by some people’s measure but it isn’t doing nothing.

If the current crisis is indeed unprecedented, why not increase the funding and resources to battle-tested measures? When earthquakes or tsunamis strike, we rush in more doctors and supplies. We don’t use untested medical procedures or set up new relief agencies on the fly.

Here I think the counter argument could be that the “battle-tested” measures may not be sufficient. Still, if the current crisis is unprecedented why not do some things that prior to this crisis were “politically infeasible”? For example, Greg Mankiw favors reducing the payroll tax immediately and phasing in a gasoline tax to replace the revenue. This strikes me as having a number of good selling points,

  1. it puts money in people’s hands immediately and does so every pay check,
  2. it puts money in the hands of those most likely to spend it–i.e. those at the lower end of the income distribution,
  3. it actually would reduce emissions far more effectively–i.e. for those who really think global warming is a serious problem this is a damn good first step,/li>
  4. any reduction in our demand for gasoline would reduce revenues flowing to the Middle East, and from there into the hands of terrorists.

Of course the draw back is that it is a new tax, but it merely replaces one that we had before. Further, it is one people can try to avoid by driving more fuel efficient cars. And to the extent that the rich drive larger less fuel efficient cars this is a tax on the rich. Do we see anythink like this in the stimulus bill during this unprecedented economic crisis? No.

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Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.


  1. Tlaloc says:

    The problem with your post, Steve, is that you very effectively demolish the credibility of economics as a whole in the first blockquote… and then go on to build an argument based on economic theories.

    Strangely enough that doesn’t really work very well.

  2. PD Shaw says:

    According to my local newspaper, the stimulus package is going to be used to build parking (break-down) lanes on a major highway out of town. This is exactly the type of improvement that anticipates America’s needs in a 21st century economy. In the coming era, we will be driving our cars for longer periods as Japanese, American and German auto-makers fail. The availability of safe parking lanes to scavenge abandoned vehicles will allow us to get more value from our existing fleet, and perhaps even needed sources of water in the coolant tanks to boot.

    The multiplier value of break-down lanes? Priceless.

  3. William d'Inger says:

    Having read your whole article twice, Steve, and I have come to the conclusion that you are essentially arguing that the economy is like a woman’s moods. You figure you have to do something, but you’ll never know whether it worked or not. It seems to me economists would be just as useful to society if they spent their time picking lottery numbers.

  4. Steve Verdon says:

    Tlaloc and William,

    There is truth in that economists are not in agreement on what needs to be done. But there are smaller, less grandiose things that can be done that could help and are not bad policy in general–e.g. the payroll tax/gas tax swap. I’ve heard liberals complain that the payroll tax is regressive and unfair. Well a gasoline tax could help with that. It would provide some stimulus and possibly without too much damage to the long term fiscal picture.

    However, you don’t get good policy by rushing things through. Think about your personal life. When you need to get something done that should be accurate and complete…is rushing a good idea, or is slowing down taking a deep breath and doing it right the first time the best approach? I’m thinking the latter is more important.

  5. steve s says:

    The republicans most of last year claimed nothing was wrong, everything was fine. The right-wing blogs mocked Paul Krugman in 2005 for saying we had a housing bubble. McCain said everything was fine and dandy.

    Now I look around and see bank implosions, rising unemployment in every state, layoffs, layoffs, layoffs, state budget crises, I can hardly find a job…

    that’s not fear mongering, dude. That’s just reality. The WSJ, just like other propaganda arms of the numbnuts who got us into this mess, can bite me.

  6. sam says:

    All this back and forth between economists and the uncertainty it reflects reminded me of something the English anthropologist E.E. Evans-Pritchard discussed in his book Witchcraft, Oracles and Magic Among the Azande. The Azande are an African tribe, and they employ what is called the “poison oracle” to determine whether someone is being bewitched by someone else. Basically, they feed a poisoned preparation to a chicken then ask a series of questions. The cumulative answer to the questions is determined as “yes” or “no” depending on whether the chicken survives the poisoned preparation or not. This oracle, of course, takes place within a complex of beliefs and practices that form the Azande worldview. Evans-Pritchard said that if he were an Azande, he would believe in witchcraft, and, given the Azande worldview, the poison oracle is a good as anything else for ordering one’s life.

    Maybe we should fashion a poison oracle of our own and try and determine which economists are bewitching us and which are not…or, if it’s a really, really good oracle, it might tell us that the whole tribe is trying to bewitch us.

  7. Steve Verdon says:

    Steve S,

    The economy is bad, yes. It is not however, as bad as Obama, et. al. are claiming.

  8. Steve Plunk says:

    A quick question regarding an increase in the gas tax. What will that do to my trucking business? Does it seems fair to burden an already hard hit industry with additional taxes?

    Back to the main thesis I believe fear mongering is being used to get this stimulus passed quickly in order to hide the payoffs to those who elected our new President and members of the congressional majority. Public works are that payoff.

    Right now not only are the American people losing confidence in the economic situation but more importantly American business has lost all confidence in what the next few years has in store for us. That means no investment in equipment and no expanding of payrolls in anticipation of growth.

    We fear higher taxes, greater regulation, and an energy policy that will likely hurt the economy more. We fear open trade will become a victim of Dem payoffs to union workers. We fear socialized medicine will cost us a bundle. We fear being demonized for merely wanting to make a, gasp, profit. A profit for simply providing goods and services to those who voluntarily pay for them.

    No stimulus will overcome such fear. The only solution is a promise that will never happen. A promise to forgo tax hikes at all levels, to reduce rather than increase regulations, and create an energy policy that moves us toward energy security. We know those promises are not reality.

  9. Steve Verdon says:

    A quick question regarding an increase in the gas tax. What will that do to my trucking business? Does it seems fair to burden an already hard hit industry with additional taxes?

    Well…on one hand you will have higher gas costs. On the other you will have lower labor costs. Will they exactly offset? Probably not. Which way will it work for your business? That would require alot more data and even then I’d only be giving you an educated guess.

  10. steve s says:

    And the Economist? The Economist is fear-mongering?

    Worse than Japan?

    I hope it’s not worse than they think. I hope that the extra-lasseiz-faire crew has only boned things up horribly, not devastatingly. But that remains to be seen. In the meantime I’ll take a reality-based perspective with some margin of error over the deranged fantasies of the GOP.

  11. Steve Verdon says:

    Steve S.,

    While Japan’s economy was indeed bad, it wasn’t Great Depression style bad. Did you read the entire article? Did you read this part,

    Japan’s outcome—a decade in which growth averaged 1% a year and gross government debt rose by 80 percentage points of GDP—was not one to be proud of.

    Indeed not good at all, but it beats the f*cking Hell out of 25% unemployment and a 9% reduction in GDP on an annual basis.

  12. odograph says:

    I don’t know if I go as far as Martin Wolf, but he certainly has the flip-side of Steve’s Japan view:

    Japan’s lessons for a world of balance-sheet deflation

  13. Anderson says:

    Unsurprisingly, the same column lauded by Mr. Verdon is cited for “The single dumbest independent clause you’ll read all day” by Dave Noon:

    “The depressions and panics of the 19th century ended without any fiscal stimulus to speak of…”

    Right. And I suppose we could note that the Spanish influenza pandemic “ended without any major vaccination efforts to speak of.”

    That sounds about like what “Dr. Verdon” would have preferred. Don’t interfere with the virus – YOU’LL ONLY GROW STRONGER VIRUSES! With lots of perfectly true commentary about natural selection, etc.

    Leaving aside the fact that, in the long run, we are all dead. (Or in the short run, in the Spanish flu case.)

    Of course, according to Mr. Verdon, the Great Depression surely persisted through the Depression and into the 1950s. Because spending never works.

  14. William d'Inger says:

    Now I look around and see bank implosions, …, that’s not fear mongering, dude. That’s just reality.

    There is more to this than meets the eye.

    I was at a gathering recently where a bank employee said that when his bank didn’t apply for a bailout, the government gave the institution a ultimatum: “You will apply for such and so amount of funds or you will suffer consequences.” Naturally, the bank took the hint.

    OK, I know hearsay is not a reliable source of information, but it had a ring of truth about it. If so, it inflates the fear statistics cited in the above quote. In other words, the government is artificially creating some of that “reality”.

  15. odograph says:

    William, I’ve read a lot of reports like that. There are a number of arguments for why it might not be terrible news. One at the time was that banks might have needed money but wanted to avoid the stigma of asking for it. So by getting everyone to take a token, the truly needy would have cover. It allowed everyone to say that they weren’t the needy one.

    That said, much is hidden in such a deal from us tax payers. Who really needed money? How badly? Was this a sweetheart deal for anyone?

    .. I watched the recent Frontline (it’s on-line), and if you want some serious “fearmongering” listen to the reports of Paulson/Benranke talking to each other and to congress. Was it that bad? If it was then the strong-arming was justified. If not, then no.

  16. Steve Verdon says:

    That sounds about like what “Dr. Verdon” would have preferred. Don’t interfere with the virus – YOU’LL ONLY GROW STRONGER VIRUSES! With lots of perfectly true commentary about natural selection, etc.

    Gee Anderson that is exactly what I argue…oh wait I did have the part about payroll tax/gas tax swap. Can you try to be honest?

  17. Bithead says:

    Of course the draw back is that it is a new tax, but it merely replaces one that we had before. Further, it is one people can try to avoid by driving more fuel efficient cars. And to the extent that the rich drive larger less fuel efficient cars this is a tax on the rich.

    I’m not sure that can properly be said, Steve.
    Less well off people tend to buy used. Which means, they’ll be buying the larger cast-offs.

  18. Anderson says:

    Yglesias sums it up:

    Amar Bidhe, WSJ Edit Page, Embrace Regular Recurrence of Massive Recessions

    We can add “OTB” to that headline.

  19. Steve Verdon says:

    Well Anderson I expect that kind of foolishness from Yglesias whose understanding of economics is slightly above that of Kevin Drum’s. I have come to expect more form you, but this latest dishonesty is disappointing.