Monday, October 24, 2011

The Animal Spirits of Capitalism Continued

I hope that most Americans have finally gotten the message that financial markets aren't necessarily rational and on the down and upside of the business cycle can be absolutely crazy and horribly damaging.

There does seem to be a fair amount of agreement that our economic troubles are caused by a "lack of confidence" in the future, The question is how do you calm these skittish wrecks and move the economy forward. I mean how do you restore confidence to our economy?

I think there are basically two competing paradigms on the restoration of confidence. A supply side approach and a demand side approach.

The supply side approach is the primary approach of the Republicans but also seems to be the dominant theme for Obama's economic advisers. The first step is to restore the confidence of Wall Street by demonstrating calm and moderation. Secondly, you make a commitment to keeping future interest rates and taxes down by cutting the size of government and closing the deficit. Finally, you create even more incentives for investment by lowering tax rates, simplifying the tax system and deregulating the economy. Add to that recipe free trade agreements and tax-free repatriation of foreign profits.

The demand siders assume that the problem is lack of effective demand in the economy. That businesses aren't investing because they are not confident anyone will buy their products. Furthermore, lower taxes or incentives will have little impact since firms are making huge profits and have even larger accumulations of cash which they are not investing. Furthermore, they would argue, that it is deregulation that got us here in the first place.

They would suggest restoring the confidence of consumes by quenching their desire for fairness and ensuring that the people who created the crisis are those who are paying for it. The public doesn't have any confidence in government to a large extent because they believe the government looks after the interest of big corporation and banks and does little to represent them. Perhaps, if there was an effort to create more fairness in the distribution in the costs of the recession and lay the blame where they think it belongs, then consumers may have more confidence, provide more political support for a bigger stimulus and perhaps be willing to go out and spend more. This approach incentivizes buying.

Supply siders respond by saying, nonsense, now you'll really scare them and they will never invest again and take all their money to Greece or China.

What is the answer for restoring confidence? I think a little of each perhaps. Signal to the public that you believe that the middle class and the poor have paid too much of the cost of the recession and that Wall Street and their owners need to pony up a larger share. But combine this with a thoughtful and certain long term deficit plan.

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