The Failure of Central Planning Lite
Robert Samuelson recently described the current economic upheaval as "the crisis of the old order," a collapse of the economic dogmas and institutions of the past few decades. I was particularly struck by one of the items he lists as the pillars of the old order, "faith in routine economic expansion." Except that this doesn't describe what he's really talking about. What he's actually talking about is faith that government officials can manage and control economic growth. "Economists exaggerated their understanding and control. They seem to have exhausted conventional policy approaches." Specifically, he points out that the usual theories of monetary and fiscal "stimulus" have failed. "Central banks such as the Federal Reserve have held interest rates low. Budget deficits are high." Yet here we are.
If anything, Samuelson's summary is understated. Mohamed El-Erian puts it in more alarming terms.
I don't know about you, but whenever I am in an airplane experiencing turbulence, I draw comfort from the belief that the pilots sitting behind the cockpit's closed door know what to do. I would feel very differently if, through an open door, I observed pilots who were frustrated at the poor responsiveness of the plane's controls, arguing about their next step, and getting no help whatsoever from the operator's manuals.
So it is unsettling that policymakers in many Western economies today resemble the second group of pilots.
Ben Bernanke printed massive sums of money and pumped it into the economy, and when that didn't work, he printed more money and pumped it into the economy, heedless of the inflationary risk. He's beginning to look like an incompetent car mechanic: he jams his foot on the accelerator and nothing happens, so instead of taking his foot off the gas, he just keeps it jammed there, guaranteeing that when the engine does spring back to life the car will lurch forward uncontrollably.
Similarly, Obama's economic advisors assumed that the fiscal stimulus would produce the neat little "multiplier" they learned in their Keynesian economics textbooks, so that spending $800 billion would automatically lead to at least $400 billion in new, additional economic activity, an amount that ought to have guaranteed a decent year of growth in 2010. But the multiplier didn't multiply, the growth never happened, and now the ratings agencies are demanding that the US replace this stimulus with contraction, cutting trillions of dollars in future spending to compensate for the money squandered on the stimulus.
In both realms, monetary policy and fiscal policy, the past few years have given the lie to Washington's assumption that competent economic management at the Fed and the Treasury could stimulate growth, maintain it, and burst any speculative bubbles with a brief, painless "soft landing."
This system can be thought of as Central Planning Lite. By the time Communism collapsed in 1989, it was no longer plausible to claim that full-blown socialism or full-blown central planning were the wave of the future. But our political and intellectual leaders were not quite willing to give up on the dream, so they insisted that we could have a watered down Third Way between capitalism and communism. Instead of having the government take over all industries and provide for everyone's needs directly, we would have a welfare state in which the government merely provides a "safety net" of subsidies. And instead of direct central planning, we would have indirect central planning. Rather than outright edicts, we would use subsidies and tax breaks to steer economic activity into the channels our political leaders prefer, such as "green" technology. And at the center of it all, instead of having Gosplan dictating steel production quotas, we would have the Federal Reserve Board dictating interest rates. This is a form of central planning for credit, in which the Fed attempts to direct how much and on what terms bankers will lend.
The debt ceiling debate, which is driven not so much by the immediate prospect of default but by the long-term unsustainability of the federal debt, shows what happens when the welfare state comes crashing down. And the Fed's failure to encourage lending and stimulate economic growth, despite yanking on all of the levers it can reach, shows the illusion of monetary central planning.
The failure of Central Planning Lite cannot just be attributed to incompetence or politicization, to shovel-ready jobs that are not shovel-ready, or bailouts organized as favors to political pressure groups. After all, Ben Bernanke was a respected and impartial economist. But the job of central planning is inherently impossible; even the smartest person can't do it.
In discovering this fact, we are emerging from a specific illusion created by one man: Alan Greenspan. When he stepped down as Fed Chairman, I noted the irony that the onetime champion of the gold standard had instead established the Greenspan Standard: the markets' faith that economic contractions would be moderated, growth would continue steadily, and inflation would be kept at bay, all because of one man. It was the illusion that a brilliant, dedicated, all-knowing "maestro" could control the markets and make Central Planning Lite work.
Yet we can now see that in seeking to mitigate the effects of previous economic downturns, Greenspan helped set the stage for a monetary expansion and the resulting housing bubble, and when he handed his power over to the sorcerer's apprentice, all hell broke loose. In dictating an expansion of credit, the central planners at the Fed replaced the individual plans of bankers, investors, and borrowers, deliberately overriding any signals that might have warned of excessive risk and called for a contraction of credit. Yet the central planners did not, in fact, know how to understand and control the easy money forces they had unleashed. So is it any wonder that they have been unable to marshal those same forces to summon up a recovery?
If any good is to come from our current economic ideal, it will be a hard-earned skepticism about any claims that Congress can design an economic stimulus package, or that a gifted maestro at the Federal Reserve can summon economic growth at his command. It will be the death of Central Planning Lite.