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Washington Examiner


No More Quick Fixes

July 27, 2012

By Guy Sorman

Economists, politicians and pundits looking for answers to the economic crisis fall into two broad categories. Keynesians and statists believe in flexible, "discretionary" economic policies; classical liberals believe in set rules.

Economic history proves the superiority of the second approach, but democracy often makes the first more attractive to politicians. In a crisis, people expect their leaders to do something; inaction and adherence to abstract principles plays poorly to public opinion. As previous recessions demonstrate, however, public pressure for action usually leads to bad decisions.

Since the beginning of the crisis in 2008, governments have lurched from side to side, to little good effect. True, some basic market-supporting rules -- those that back free trade and oppose inflation, monopoly and the nationalization of industry -- have held since 2008. This stability compares favorably with government responses to the Great Depression in the 1930s, which made things worse by permitting nationalization and monopolies while interrupting the free flow of goods, capital and people.

In 1974, too, wrongheaded policies magnified a crisis. After oil-producing nations formed a cartel, OPEC, and boosted oil prices dramatically, Western production costs shot up, smothering consumer spending and bringing the economy to a standstill. To reignite growth, Keynesian economists persuaded central banks to print more money than ever before. The result was disastrous stagflation -- economic stagnation and inflation combined.

Governments and economists fortunately haven’t repeated the worst mistakes of the 1930s and 1970s. That may explain why the current crisis hasn’t become even more serious. Yet public pressure to act remains.

How can governments resist the temptation to adopt short-term policies and instead promote long-term, steady approaches to maintain economic growth? Here are some suggestions.

Instead of holding an endless debate on taxes and deficits, classical liberals in the United States should promote a constitutional amendment that imposes a ceiling on total federal spending. Throughout the history of capitalism, the level of public spending has had a greater impact on GDP growth rates than has the size of the federal deficit or the marginal tax rate. In America, a public-spending cap would calm the anxieties of entrepreneurs and consumers, make the future more predictable and provide a strong incentive for businesses to invest the huge quantities of liquid assets now frozen or invested in unproductive bonds. The amendment would restart the innovation cycle that has always been the main driver of American economic expansion.

Long-term rules in the United States could also put an end to the excessive concentration of political and financial power in the hands of a limited number of banks -- a problem that helped disrupt the world economy in 2008, and threatens to do so again. As University of Chicago economist Luigi Zingales shows in his new book, "A Capitalism for the People: Recapturing the Lost Genius of American Prosperity," the United States increasingly risks becoming, in economic terms, a "banana republic" -- a place where a few big banks destroy public confidence in the free market and deplete the economy’s resources through short-term speculation instead of investing. New rules could put a stop to that by limiting the size of banks, which would re-establish competition.

Classical liberals could also push to make the Federal Reserve’s monetary policy more predictable. As Milton Friedman demonstrated half a century ago, the American economy grows steadily when the Fed injects money and credit into the economy in steady and predictable quantities. When the Fed tries to do more, it usually generates speculative bubbles, inflation and stagnation. Stanford economist John Taylor has proposed an algorithm for the Fed that would adjust monetary creation to the needs of the economy. The "Taylor Rule" should become a legal constraint on the Fed, preventing it from adopting discretionary and counterproductive policies.

In a democracy, it is easier to find what should be done than it is to implement it. But it is up to political leaders to build constituencies that will support rules instead of discretionary policies.

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