Unlimited Government: Central Banks and Federal Spending during the Corona Crisis

Q: We’re in a very odd situation right now in terms of evaluating the state of the economy. We can see there is rising unemployment and there is likely to be a wave of missed mortgage and rent payments. Is this all just due to the government-mandated “shutdowns” or are there deeper economic issues here?

A: Extremely odd! The rising unemployment and missed mortgage and rental payments will be linked to the government-mandated shutdowns, but the overall economy was already weak beforehand despite record stock markets and record low unemployment in late February. Savings were low and debt at all levels was very high. Job openings hit a record high in early December 2019 and were declining noticeably well before the virus and shutdowns hit. Therefore, I was expecting a weak economy in 2020 and the shutdowns brought it about sooner than anticipated and have no doubt made it worse. So, we have in effect both a business cycle depression and the economic restriction of the lockdown at the same time. I would not have been surprised if we had reached 10 percent unemployment, but obviously it would not have occurred so quickly without the shutdowns.

Q: As the crisis grew during March, the Fed lowered the target rate from 1.75 to 0.25 percent in a two-week period. Since then, the Fed has begun engaging in a wide variety of asset purchases. What was the Fed trying to do when it did this, and can it achieve its goals?

A: The Fed is always trying to manage “confidence” and so keeping companies from going bankrupt is a big part of its agenda. Lower rates mean lower payments for mortgages, car payments, etc. Purchasing assets like junk bonds hides the bad news that is no doubt out there. So far, their plans have worked, with stock markets reflecting good news. However, precious metal prices are also up, so not everyone is being fooled by the Fed’s confidence game.

Also, the personal savings rate has spiked to 30 percent, to one of the highest levels on record. That is an obvious sign that many people are not accepting the idea that Fed policy will take us quickly to a recovery.

Q: We seem to now be in a time of unprecedented fiscal and monetary stimulus. In the past, there seemed to be some political and legal limits on what could be done in this regard. Why do you think there are now almost no limits on what the Fed and Congress can get away with in terms of spending and bailouts?

A: It is truly remarkable. In the past we had the gold standard restraint on fiscal and monetary policy (until 1971). That restraint had a lingering effect for a long time. However, the current group of voters and politicians no longer recognize that restraint or the consequences of ignoring a balanced budget restraint. The average American has no memory of the gold standard or even the stagflation of the 1970s. The current generation does not even recognize the idea of a government budget! The collective mindset is the classic “kick the can down the road.”

Obviously, the idea of a national debt limit is now rightly regarded as a joke.

Q: It’s now looking like the federal budget may exceed 10 trillion for 2020, and that means a deficit of more than 2 trillion just for this fiscal year. But, it seems no one—including the voters—have any concerns about deficits at all. Why should we care?

A: Ten trillion?

The deficit will hit an all-time record high. Spending is out of control and tax revenues will probably miss the initial estimates. The millions of unemployed will likely have a hard time making tax payments. Expenditures for things like unemployment insurance and welfare payments will likely remain high. I think I am most concerned about interest paid on the national debt, as an uptick in rates could cause such payments and the deficit to balloon.

Why should we care? The simple reason is that all this spending eats up real resources. The government buys something and the resources are not available for productive use. GNP (gross national product) goes up, but what are the real benefits? The government writes welfare payments or unemployment insurance checks and potential workers stay unemployed. It also raises future taxes. Good economic policy is about increasing private production and free trade. Bad economic policy is about living beyond your means and protectionism.

Q: Although many regard what the Fed is doing to be unprecedented and even outlandish, it seems that other central banks are doing even more. That seems to be the case over the past ten years: while the Fed pursued easy money policies, other central banks did even more. Do you think that will be the case in this crisis also?

A: Yes, while Fed policy is outlandish, other central banks are doing even worse. In particular, the Bank of Japan and the European Central Bank have been doing more so in terms of interest rates and buying assets. The Bank of Japan has increased its balance sheet 500 percent over the last decade, and they have had a near-zero interest rate policy for many, many years. The interest rate on Greek ten-year government bonds is 1 percent, for Spain it is 0.4 percent due to ECB asset purchases. Under normal circumstances who would lend to such governments for ten years for less than 1 percent interest? That says it all.

It might seem that central bankers can paper over all our problems, but that will not be the case. Take a look at countries that have negative interest rates, negative interest rates on government bonds, and even negative prices for oil in futures markets. These are troubling facts that the world economy is fundamentally unbalanced.

The upside here is that this crisis holds the promise to discredit mainstream economics and fiat money.

Author

  • Mark Thornton is the Peterson-Luddy Chair in Austrian Economics and a Senior Fellow at the Mises Institute. He serves as the Book Review Editor of the Quarterly Journal of Austrian Economics. His publications include The Economics of Prohibition (1991), Tariffs, Blockades, and Inflation: The Economics of the Civil War (2004), The Quotable Mises (2005), The Bastiat Collection (2007), An Essay on Economic Theory (2010), The Bastiat Reader (2014), and The Skyscraper Curse and How Austrian Economists Predicted Every Major Crisis of the Last Century (2018).

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