Deck 15: Economic Performance and Real-World Politics

Question 1

Karl Marx believed that the boom-bust cycle is an inherent and natural feature of the market-capitalist economy. While most Marxists have jumped ship, today some of the more radical followers of John Maynard Keynes (who call themselves Post Keynesians) argue that increased entrepreneurial risk taking will inevitably create booms and corresponding collapses. In fact, they say the Great Recession confirms their case. But this much is true: nations have some sort of central bank that manipulates the money supply, and often those banks face political pressures to create cheap credit, which your authors argue can launch unsustainable booms. Do you think this supports the claims that booms and busts are a natural feature of capitalism?

Answer 1

A boom and bust cycle is a cyclical process of expansion and contraction in an economy. Capitalist economy faces the boom bust cycle repeatedly.
If the government and the central bank of a capitalist economy are a necessary institution then one can say that the boom and bust cycle is a natural concept.
If there is a possibility of issuing private note under the free banking system which means that the central bank does not exist then one can argue that the source of any boom which is unsustainable would be eliminated.

Question 2

Are all economic downturns caused by excessively expansionary monetary policy? Suppose, for example, that a country is crippled by war. Couldn't that, too, reduce a nation's real GDP in both the short and long runs?

Answer 2

Monetary policy is a policy which is used to control the inflation by adjusting the money supply. Open market operation, CRR and SLR are some example of monetary policy.
Expansionary monetary policy can cause economic downturn but it is also true that war, floods which destroy the infrastructure and other resources which are scarce lead the economy into a situation of recession and there will be a decline in the level of real GDP in the economy.

Question 3

There's an old joke that goes like this: "Professor, what's the difference between a recession and a depression?" The professor responds, "A recession exists when you are out of work. A depression occurs when I am out of work." Joking aside, what is the difference?

Answer 3

A boom and bust cycle is a cyclical process of expansion and contraction in an economy. Capitalist economy faces the boom bust cycle repeatedly.
Recession is a situation in which the real GDP of an economy slow down or decline for two consecutive quarters. In recession the out and employment of an economy will fall and the borrowing of the government will increase.Depression is a more severe situation of recession and it arises due to prolong and deep recession.

Question 4

Your authors have used a couple metaphors to describe the cycle-one was the bite, chew, choke found in Figure 15-1. The other one- misdirection caused by too many green lights turned on thanks to government intervention-ties into our discussion of traffic, signals, and rules that go all the way back to the beginning of chapter 1. (The green light metaphor first appeared in Steven Horwitz and Peter Boettke, The House that Uncle Sam Built [Foundation for Economic Education, 2009]-just do a Google search.) Here's another one we like (which is not original to us): Think of the boom as the Fed secretly spiking the punch bowl at a party. The guests have a grand time as the night advances, without realizing that they're drunk. But at some point the equivalent of the crash-the hangover-is inevitable as the body reacts to and corrects itself from the alcohol-fueled boom. How might the pain of the hangover be resisted? (Hint: think "hair of the dog.")

Question 5

How long is the long run? Keynes accused his predecessors of ignoring the problem of recessions by assuming that they would correct themselves "in the long run." In a book written some years before The General Theory , he observed caustically that in the long run we are all dead.
(a) Suppose you think there is a 0.25 probability that by trying to remedy a recession the government will in fact make it worse, but that it will cure itself "in the long run." How long would you want to wait before accepting the risk of making matters worse?
(b) How long must a recession continue, or a recovery be delayed before we're justified in assuming that recessions are not merely "temporary disturbances?"

Question 6

How independent of each other are monetary policy and fiscal policy?
(a) Under what circumstances could the federal government run a large budget deficit without thereby producing an increase in the size of the money stock?
(b) Suppose the Fed determined to run a "tight" monetary policy, allowing no growth in commercial bank reserves, at a time when the federal government was trying to borrow to finance a large budget deficit. What would happen?
(c) Assuming that interest rates are set by the demand for and supply of loanable funds, under what circumstances could a large increase in federal government borrowing not produce higher interest rates?
(d) Suppose the Fed tries to prevent the increased government demand for loanable funds from raising interest rates by increasing the supply of loanable funds through an expansion of commercial bank loans. Will this Fed policy succeed in preventing interest rates from rising? At what point will the Fed's expansionary policy step up the inflation rate? How will the expectation of a higher rate of inflation cause interest rates to rise?
(e) Suppose that the federal government begins to run a large budget deficit at a time when many productive resources are idle-factories are operating far below capacity in most industries, and there are surplus supplies of labor in almost every area of the economy. How might the existence of all these idle resources prevent even a very large increase in government borrowing from leading to an increase in interest rates?

Question 7

If Congress wants to use fiscal policy to counter recessions, should it cut taxes when the recession is a suspicion, when it's a widespread conviction, or when it's officially announced?

Question 8

Here's another joke economists like to tell on themselves: if all the economists in the world were laid end to end, they would reach-no conclusion. President Harry S. Truman is said to have longed for a one-armed economist, because all the economists who advised him were inclined to say, "On the one hand,.. but on the other hand. " Perhaps these two characteristics are related.
(a) Can you think of a single economic policy not now in effect that you would like to see adopted that does not entail some possible or even probable consequence that you would not like to see come about?
(b) "The policy may not work, but we ought to try it anyway, because we have to do something." How probable is it that the person making such a statement believes rather strongly that the policy will work, and that people who are against the policy believe strongly that it will not work?
(c) A standard way of assessing alternative policies is to predict and Assess their probable consequences. Is there any definite limit to the number of consequences of a particular social policy?
(d) Someone says, "This problem will work itself out. Government intervention is not required." Does it matter how long the problem takes to "work itself out?" Do you think proponents and opponents of the policy are likely to agree on how long this will be, even if they agree that it will eventually "work itself out?"

Question 9

Suppose that every member of Congress genuinely believes that government expenditures are excessive and ought to be reduced by at least 10 percent. Why would this not be sufficient to assure a 10 percent reduction?

Question 10

Suppose a member of Congress votes against a bill to allocate $100 million in taxpayers' money to an irrigation canal that will provide about $10 million in benefits to a few hundred ranchers. Why might this action cause the legislator a net loss in both votes and campaign contributions?

Question 11

Why do so many members of Congress believe that the federal government should subsidize local projects, such as improvements in bus or subway systems in major cities?
(a) Who would benefit from construction of a subway system in a large city?
(b) Can you think of a public-interest argument for having taxpayers across the country pay for a local subway system?
(c) If you knew that your taxes were going to go up $10 a year in order to finance a subway in some distant city, would you write a letter of protest to your legislator?
(d) If your city was being considered for a large federal grant to subsidize an improvement in the local public transportation system, would you expect your local government officials to go to Washington and lobby actively for it? Would you expect your congressional representatives to support it? Would you form a more favourable opinion of local officials and congressional representatives if your city proved successful in its grant application?

Question 12

If you favor reduced government expenditures, do you also favour reducing government financial assistance to college students?

Question 13

Voters who don't want their taxes increased impose obvious constraints on any democratic government's ability to raise additional revenue, but there are other constraints as well.
(a) How can people legally avoid a state income or sales tax?
(b) Voters don't seem to be terribly hostile toward increased taxes on business. Why can't state and local governments collect all the revenue they want simply by raising taxes on businesses?
(c) Why don't these constraints bind the federal government as Effectively as they bind state and local governments?

Question 14

Do you think that people who "live beyond their means" display a character flaw? What about a government that fails to confine its expenditures to the amount of its tax receipts?

Question 15

Suppose the Treasury borrowed $20 billion in September of the presidential election year in order to increase the benefits to be paid on October 1 to recipients of Social Security benefits, welfare grants, and unemployment compensation. What would be the effects on the money supply? On consumer spending in October? On the unemployment rate? On the price level? On the election? When would you expect these various effects?

Question 16

The Federal Reserve was created to be an independent agency of the federal government-independent, that is, of the immediate political pressures that are felt by elected officials and appointed officials whom the elected officials can demote or discharge.
(a) Is it "undemocratic" to have an organization as powerful as the Fed that isn't answerable to the voters?
(b) If Fed officials had to answer to elected officials, would that make them answerable to the voters?
(c) Under which of these three circumstances do you think it is most likely, and under which do you think it is least likely that monetary policy would promote the public interest: the present system, a system under which presidents could dismiss Fed officials the way they can now dismiss cabinet members, or a referendum system under which the Fed's policies would have to be periodically approved by a majority vote of the electorate?

Question 17

How independent is the independent Fed? Fed officials and Treasury officials regularly cooperate to smooth the financing and refinancing activities of the federal government as it borrows the vast sums required to cover current deficits and refund the huge national debt.
(a) Don't people who work cooperatively usually come to see their problems in similar or at least compatible ways? Isn't the Fed more likely to conclude that a particular monetary policy is the best policy if it also happens to ease the financing problems of the Treasury?
(b) The Treasury would like to keep down the costs of its borrowing and refunding. How could the Fed help achieve this laudable objective?
(c) If the Fed tries to provide enough reserves to the banking system to make sure that borrowing costs don't rise during large Treasury borrowing operations, what must it do? Why might a succession of such cooperative moves by the Fed eventually cause interest rates and Treasury borrowing costs to rise steeply?

Question 18

In 2013 U.S. government policymakers flirted with the idea of minting a $1 trillion platinum coin and having the Fed purchase it. The Fed would basically print up a trillion dollars and hand it to the Treasury (either that or make an electronic transaction). The proceeds would allow the government to avoid its debt ceiling. Why didn't the Fed propose minting the coin with, say, Mickey Mouse's face on it, or even minting an official $1 trillion plastic coin? And no matter what material the government would use to mint the coin, is the proposal inflationary?

Question 19

"Fear the Boom and Bust," a rap video produced by Russ Roberts and Jon Papola, has over 4 million views on YouTube. It is a light hearted but timely presentation of the positions of John Maynard Keynes and F.A. Hayek on the business cycle. (The boom-bust analysis presented in this chapter has been greatly influenced by Hayek and his professor, Ludwig von Mises.) Take a look at it and the follow up to it called "Fight of the Century: Keynes vs. Hayek Round Two." What's your impression? Who do you feel wins? Does the video get complex ideas across in an accessible way?