I'm Not Against Growth And, By The Way, I Never Beat My Wife, Either
"Growth is the intellectual dividing line in American politics. Free market supply-siders embrace it; it makes orthodox
economists nervous." So wrote Lawrence Kudlow on the op-ed page of Friday's Wall Street Journal. I see. If you
question the longevity of the economic growth that results from the central bank's distortion of resource allocation by
holding interests rates below their "free-market" levels, then you are anti-growth and, therefore, a central-planning
nervous-Nellie orthodox economist, whose mother probably wore combat boots!
I happen to know of a school of economic thought that might take exception to Mr. Kudlow's assertions. That school is
the Austrian school, whose luminaries included Ludwig Von Mises and Friedrich A. Hayek, may they rest in peace.
These guys were ardent advocates of free markets. In fact, The Wall Street Journal ran an op-ed piece several months
ago in honor of Hayek's birthday, extolling his adherence to free-market principles.
If Hayek were alive today, I would be willing to bet that he would have already e-mailed The Journal a blistering rebuttal
to Mr. Kudlow's drivel. For you see, Austrian economists view central banks, by their ability to create credit at a
keystroke, as creating distortions in the credit market, which, in turn, creates a misallocation of resources throughout the
economy. In 1929, prior to the October stock market crash, Hayek warned of an impending business crisis because of
Federal Reserve policy. Inflation at that time was even tamer than it is today. Yet, Hayek argued that the Fed had sown
the seeds of a major economic downturn by its credit creation policies in the 1920s prior to 1929.
Hayek reasoned that a central bank policy of price stability in the face of strong productivity growth was inappropriate.
If productivity were growing, the general price level should be falling apace with that productivity growth, not be stable.
Because the determination of the general price level is a function of the supply of money, and because, in a fiat money
system (as opposed to a chevrolet system), the supply of money is a function of central bank created credit, a stable
general price level in the face of productivity growth must imply that the central bank has created "excess" credit and
money so as to prevent the general price level from falling.
So what's wrong with that? And what does it have to do with interfering in free markets? The way that the central bank
creates this excess supply of credit and money is by keeping interest rates lower through discount and/or open market
policy than they would have been in an unfettered free market. The central bank is a monopolist, if you will, in its ability
to create credit. By holding interest rates below their free-market determined level, the central bank encourages
expenditures which otherwise would not have taken place. The central bank, in effect, is subsidizing expenditures, and,
by so doing, is promoting the misallocation of resources.
For example, the lower interest rate might encourage the production of investment-type goods. This means that finite
resources - yes, in contrast to Mr. Kudlow's never-never land of an infinitely-elastic supply curve of productive
resources, the Austrians believe that resources are limited at any point in time - would be used to produce goods that at
some time in the future could themselves be used to produce goods for immediate consumption. However, the labor
resources used in the current period to produce these investment goods want to consume more goods currently. They
didn't enter into a contract to curtail their consumption now so that resources could be used now that otherwise would
have been used to satisfy their current consumption needs. In other words, they did not willingly agree to transfer their
claims on resources for current consumption to entrepreneurs for the latter's use in producing investment goods.
This excess demand for consumer goods sets up a chain reaction of events, which will ultimately end in a business
downturn, and, depending on the behavior of the central bank, not only relative inflation, but absolute inflation, too. The
excess demand for consumer goods will drive up their prices relative to capital goods prices and cause businesses that
produce and distribute consumer goods to bid labor and other productive resources away from the investment goods
sector. This will drive up the costs of production for investment goods producers, making their projects less profitable
and causing them to borrow more funds to pay the higher costs of production. But, assuming that the central bank stops
holding down interest rates, the increased demand for credit by investment goods producers will drive up interest rates,
making the production of these investment goods even less profitable. Abandonment of the production of these
investment goods will then occur, triggering a general business downturn. If, on the other hand, the central bank still is
preventing interest rates from rising to their free market level, inflation will start to rise. The higher inflation will cause the
central bank to create more and more credit and money if it wants to maintain the level of interest rates. This process will
lead to an upward spiral in inflation. Ultimately, the central bank will slam on the monetary brakes, which will cause the
economy to crash.
So, Mr. Kudlow, if productivity growth is as strong as you claim it to be - and, by the way, I can't seem to replicate your
productivity growth rates from BLS-published data - then the general price level ought to be falling, not just the price of
computers. And the capital spending boom to which you such proudly point, is exactly what Hayek would have
predicted given his view on central bank interest rate interference. As an Austrian-sympathizer - you can tell by the
length of my sentences -- I am not against economic growth so long as it is not being stoked by central bank created
credit and money. And, oh yes, I never beat my wife.
Whew! I feel better now that I have gotten this off my chest.
Personal Consumption Outlays Post A Moderate Gain In July
Personal consumption spending, after adjusting for inflation, rose 0.2% in July, compared with a 0.3% gain during the
prior month. Expenditures on durables rose 0.2%, following a 0.4% increase in the previous month. Spending on
non-durable goods dropped 0.2% -- the first monthly decline since April. Service outlays rose 0.4% in July vs a 0.3%
advance in the preceding month. Consumption has grown at an average annual pace of 5.4% during the 1998:Q1 -
1999:Q2 period. The July consumption data suggest that (based on conservative assumptions for August and
September) third quarter real consumption spending should come in around 3-1/4%. This represents a substantial
slowing from the prior six quarters, but it is still a healthy clip of consumer spending.
Personal income rose 0.2% in July, a significantly weaker advance than the 0.7% increase in previous month. Farm
subsidies played a role in exaggerating the headline number. Farm income dropped $18.7 billion in July, following a
$17.6 billion increase in the prior month. However, wages and salaries rose 0.7% in July, compared with a 0.5%
increase in the previous month.
Asha Bangalore
Economist
Paul Kasriel
Chief Domestic Economist
ntrs.com |
