Christina Romer's Toxic Cookbook

Keynesian and other mainstream economists cannot explain the present crisis. That doesn’t seem to bother them.

All they can offer is a description of symptoms, such as with their favorite phrase: lack of “aggregate demand.” Which, if you think about it, doesn’t really explain anything. How come demand dropped? Why did it drop now and not at any other time? Whose demand dropped? (Hint: Mine didn’t.)

Sigmund Freud Meets Dr. Ruth

But hey, when faced with a lack of proper economic explanations, you can always fall back on some amateur psychology. Everything must be down to what goes on in people’s heads, right? People just get all mixed up. Too pessimistic. (Animal spirits, anybody?)

That’s why it is always up to those coolheaded guys and gals in government to use their policy tools to change expectations, change the psychology of people, cajole everybody into some elevated state of positive thinking and, hence, more economic activity. Save the masses from their own silly notions in their tiny heads, like saving and getting rid of debt. They all just clam up and save? Pitiful. But most importantly, why even worry about explaining the recession if you are confident, if you simply know, deep down in your heart, how to get out of it?

Most politicians don’t know any better. They certainly don’t know any economics. So the same toxic policy mix of Keynesian deficit spending and monetarist money printing has been implemented around the world since this crisis started four years ago. Just as in any other recession of the past 40 years, ever since Nixon cut the last link to gold and fulfilled every interventionist’s wildest fantasy: unlimited paper money under full control of the state! Yeah, baby, no more recessions!

Alas, it is not working, is it?

Rates were cut, and the state not only spent money it didn’t have…as usual, it spent much more money it didn’t have. But the economy did not recover. So more of this policy was implemented. And then, more again. In fact, by any standard, never before in modern times has the economy been “stimulated” more through Keynesian and monetarist government intervention than over the past four years.

Balance sheets of major central banks have tripled. Banks have been receiving limitless funds for free and will continue to do so forever, and governments are running deficits the likes of which mankind has only ever seen at the height of major wars, and which are increasingly funded by the printing press.

It is still not working.

You would probably guess that the interventionists of Keynesian and other ilk would be a bit more humble by now. Maybe check a few of those premises in their models? Or maybe start thinking again about those elusive explanations for what’s wrong with the economy in the first place? Are we really suffering from a lack of paper money and government spending? Maybe it is not simply down to all of us being too depressed, morose and in need of some policy Prozac. Maybe something else is broken.

Alas, no. The academically trained Keynesian economist is too committed to his or her beliefs to let the facts get in the way. Why has policy not worked? Because we have been too timid. We need the same policy. We just need more of it. A lot more.

More monetary madness

In her recent op-ed piece in The New York Times, High Priestess of Keynesianism Christina Romer suggests a radical policy “change” at the Federal Reserve: toward more money printing.

Rather astutely, she calls for Helicopter-Ben to embrace a Volcker-moment. Maybe by quoting the poster boy of the Reaganites and the hard-money crowd, she hoped to reach a new audience for her tiring and dreary, old policy recipe of more and bolder interventionism. She almost had me fooled.

Wait a minute, I thought. Volcker? He is the guy who abruptly stopped the printing press and allowed high real market rates to cleanse the system of the dislocations of previous booms, and to squeeze inflation out of the system, thus, giving the paper dollar another lease of life — albeit one that is quickly running out.

I thought, has Christina finally seen the light? Has she begun to realize how massively disruptive a constantly expanding supply of fiat money is for an economy? Is she calling, as I do, for an end to this monetary madness of zero policy rates and quantitative easing?

Well, no, she isn’t. She wants the Fed to print more money, much more. She wants the Fed to adopt a nominal GDP target. This will allow the Fed to become even more aggressive in its monetary policy and to communicate this aggressiveness better. Make people trust in that aggressiveness. And this communication is important for Romer.

As we have seen, for the good Keynesian, the policy was never wrong. The policy was just not ambitious enough. All it needs is a more-ambitious goal and better communication. People just have these bad thoughts and wrong expectations. The public is just not playing ball, not going along with this enlightened economic program. Well, says the Keynesian, we’ll teach them.

The Volcker analogy works like this for Romer: In 1979, inflation was too high, and small rate hikes didn’t work. So Volcker implemented a much tighter policy and crushed inflation. And it worked, because people believed him. Today, unemployment is too high. Gradual policy easing (not sure what planet Christina is on, but from where she is sitting, monetary policy in the U.S. must have appeared to be gradual) is not working, either.

So Bernanke needs to become more aggressive, and publicly so. Because people believe that if you stick to your policy, which — please remember — was, of course, the right policy to begin with, then the policy will really begin to work. You just need to drill it into those blockheads.

Every first-semester economics student, not only those at Berkeley — where Romer is economics professor — should be able to tear this apart with ease. The analogy with Volcker is silly. Volcker used monetary policy to fix a monetary problem: inflation. Stopping inflation by not printing money anymore is pretty straightforward. The link is kind of direct.

To be honest, it doesn’t even matter what the public believes or not. If you stop printing money, inflation will drop. Period. The link is that direct. You don’t need the accompanying belief system.

Was there full employment in Weimar Germany?

However, unemployment or the level of ‘aggregate demand’ is decidedly not a monetary phenomenon. Only in the airy-fairy dreamland of macroeconomic models is there a direct link.

To assume that we can simply and straightforwardly establish whatever nominal growth rate and level of employment we desire by means of the printing press is precisely the type of naive “building block economics” that got us into this mess in the first place. According to this worldview, the economy is just a machine, and all we need to do is to pull the right levers. Or it is like a cooking recipe, in which we need to simply change the ingredients a bit and — voila! The souffle will rise!

It is precisely because (a certain type of) economists have been telling us…that we can have more growth and high employment by constantly debasing money. This is how we created this highly levered economy over the past four decades. One that is so thoroughly addicted to ever larger fixes of cheap credit and that is now choking on excessive debt and weak banks.

By printing money and artificially lowering interest rates we have, again and again, bought near-term economic growth at the expense of long-term economic imbalances. That this was bad economics everybody is now learning the hard way. Everybody, that is, except Christina Romer. Her simple worldview is unshaken.

It is this weird combination of childlike belief in the simplicity of the problem (aggregate demand, lack of optimism) and the striking arrogance of the notion that the government can and should control the economy by simply pulling at the right strings hard enough that makes Romer’s article such an illustrative example of the intellectual dead end that is mainstream economics today.

Romer has apparently no notion of relative prices and of the importance, in particular, of interest rates for coordinating saving with investment. She cannot see that lowering interest rates administratively and injecting new money into the financial system will have many additional effects, other than lifting some statistical measure of aggregate economic activity. Easy money will always change resource use and capital allocation. Cheap credit encourages borrowing and debt accumulation, and will cause additional problems for the economy later.

Romer cannot perceive of these complexities. In her ivory tower, the world is one of simple statistical aggregates and large wholes that you can direct and mend to your liking. You just add the desired real growth rate (2.5%) and the acceptable inflation rate (2%) and stir it nicely to come up with the nominal growth rate (4.5%). How hard can it be?

We have some indication that Bernanke is not very sympathetic to this proposal at present. It doesn’t look like this will become official policy anytime soon. But who knows? A lot of what is now accepted monetary and fiscal policy in major countries and debated dispassionately by financial market economists would only a few years ago have been the mark of the economic crank, or the populist policy program of some economic backwater just before it was put under IMF surveillance.

But what is striking is this: Such rubbish emanates from the highest echelons of academic economics in America. Christina Romer is economics professor in Berkeley, Calif., and I fear that a lot of very bright young people burden themselves and their families with student loans and waste valuable time absorbing such drivel. If Romer is all that economics in Berkeley has to offer, why not emulate the late Steve Jobs and drop out?


Detlev Schlichter

The Daily Reckoning