Ask the Expert: Dan Mitchell

Matthew Schwieger, a first year MBA candidate at Johns Hopkins University's Carey Business School asks:

"Over the past several months, Cato scholars have articulated the dangers of government intervention in the market during times of economic crisis. While there are many skeptics of the bailouts, few have laid out realistic alternative courses of action. In very practical terms, what politically viable alternatives are there to the Keynesian approach the current and former administrations have taken to jumpstart the economy?"

Dan Mitchell, a Senior Fellow at the Cato Institute, answers:  

The good news is that we are able (especially with the benefit of hindsight) to identify government policy mistakes that helped to cause the economic downturn. Easy-money policy from the Federal Reserve, the corrupt system of subsidies from Fannie Mae and Freddie Mac, tax preferences for debt, and so-called affordable-lending requirements all contributed to creating a bubble that - combined with excessive leverage - has wreaked havoc.

Another bit of good news is that we know the policies that will not work. Keynesian spending, for instance, will not "stimulate" the economy. Borrowing money from the economy's right pocket and putting it in the economy's left pocket may be an effective way of redistributing national income, but the key to ending a downturn is getting more national income.

The bad news is that there is no silver bullet to make the economy better. Recessions occur because resources get misallocated (usually because of govenrment intervention). In America, for instance, interventionist policies helped steer too much labor and capital into the housing and finance sectors. that "mal-investment" is now being liquidated - a process that is painful and unpleasant, but presumably unavoidable.

There are many policies that will help the economy grow faster, such as lower tax rates, tariff reductions, deregulation, and spending cuts. But these policies are desirable because they boost the economy's long-run growth. There is nothing particularly "stimulative" that happens in the short run. Indeed, in some cases, reducing or eliminating government intervention may lead to resource shifts that are very beneficial in the long run, but uncomfortable in the short run (elimination of farm subusidies, for instance, might cause some dislocations in the most heavily-subsidized parts of the agriculture sector).

Some leaders have the integrity and commitment to weather short-run storms for the benefit of the nation. Reagan's willingness to squeeze inflation our of the system in the early 1980s is an excellent example. In most cases, though, politicians put short-run electoral considerations above what is best for the country.

More information on Keynesian Economics and related topics are available on these videos through the Center for Freedom and Prosperity Foundation:

Keynesian Economics Is Wrong: Bigger Gov't Is Not Stimulus 

Big Government Is Not Stimulus: Why Keynes Was Wrong (The Condensed Version)