The Theories of Fear

This week’s news has provided plenty of material for me to write about, from the nuclear option to the Syria strike, but none of that has distracted me from the apology I feel that I owe my readers for my post last week. I wrote about the myth that tax cuts create jobs, and I stand by that. But, in making my case, I vastly simplified matters, and in particular I denigrated the entire profession of economics. The resulting post had a tone of anti-intellectualism that goes against everything I hold dear. Things are more complicated, and economists can be very important to us in making our arguments. So this week’s post is devoted to understanding where supply-side economics came from, and what the political implications of that are.

Our politics these days is in many ways an ongoing war between two schools of economics: Keynesian and supply side. Both theories arose in response to an extreme economic event, and represent a reaction to fear. I caution, as I did last week, that I have not formally studied economics.

Keynesianism began to take hold around 1935, and was a direct response to the Great Depression. In particular, it was and is based on the fear of deflation. In any depression, consumer prices drop in response to a lack of demand, but that in turn suppresses demand, causing further price declines, and so on. John Maynard Keynes described a series of remedies for this that involved powerful government interventions to spur demand. The New Deal represented such an intervention, but so did Lyndon Johnson’s New Society programs, which were enacted at a time when the economy was already on much stronger footing than it had been during the Great Depression.

Conservatives, or what we call conservatives these days, surely object to the Great Society programs and parts of the New Deal for the ugly reason that these programs help minorities through the mechanism of higher taxes on whites. But the economic case they make is based on the fear of inflation, not deflation at all. This fear is the basis of supply side economics. In this formulation, the existing New Deal programs and Johnson’s additions were the direct cause of the hyperinflation and severe recession of the 1970s. The nation experienced periodic depressions until the big one in the 1930s, but the New Deal prevented any further depressions since then. On the other hand, we have not seen a recession as severe as the one in the 1970s since then, but the continued occurrence at all of recessions tells a supply sider that their work is not done. The so called Great Recession that followed the financial crisis of 2008 is a special case that we need to understand in the context of Keynes vs. the supply siders in order to counter their arguments.

The Federal Reserve is supposed to find a balance between the threats of inflation and unemployment by controlling interest rates. That is, they are supposed to raise interest rates when the greater fear is inflation, and lower them when the greater threat is unemployment that can bring on deflation. To a supply sider, higher interest rates are an unacceptable burden on the economy. They make it more expensive for businesses to borrow money, which encourages more price increases and creates a feedback loop. Instead, supply siders favor suppressing inflation by attacking demand. That means redistribution of wealth through regressive tax policies to reduce the buying power of workers. It means attacking labor unions in order further reduce buying power. It means promoting the idea that levels of unemployment that are high by historical standards represent a new normal brought on by demographic changes.

It would be political suicide for any candidate to say that the country needs fewer people working, and lower incomes for those who are working. Yet, that is exactly what supply side economics tells us is needed to combat the terrible threat of inflation. The economic crisis that followed from the financial crisis of 2008 is often referred to as the Great Recession, which would seem to bolster their argument. But this was not anything like a classic recession. We did not face any threat of inflation in this period. Instead, we saw severe un- and underemployment, and we narrowly averted a depression that could have rivalled the one in the 1930s. Just as supply side economics was founded on the idea that Keynesianism went too far in the 1960s, leading directly to the recession of the 1970s, so we must now make the case that the near depression that began in 2009 was the direct result of supply side policies that went too far. Even now, we face a greater threat of deflation than inflation.

To be clear, the supply siders have a valid point that we must find a balance, and understand that we may at some point need aggressive remedies against the threat of inflation. They go wrong, however, in asserting that this is such a point. A shock to the economy now would not cause inflation. Instead, it would put us back on the brink of a depression, as we were in 2009. The Affordable Care Act was the only remedy Obama was able to pass that was anything like permanent, and it hardly puts us where we were economically in 1972.Our energy policies have left us less vulnerable by far to an oil price shock than we were then. Years of increasing income inequality have left a landscape where our workers simply can not support inflation of the sort we saw in the 1970s. Aggressive union busting and the change to a service economy have made these trends harder to reverse.

It is my belief that we need to understand supply side economics and Keynesian economics as well. We need people with the skill to measure the condition of our economy, and give us the foresight to anticipate and prevent crises. But I fear that the continued dominance of supply side thinking in our politics will lead us back to the brink of the crisis we avoided in 2009. This time, Donald Trump will have neither the inclination nor the personnel around him to respond appropriately. I hope I am wrong, and that we do not need to experience an actual depression before we realize that it is the supply siders who have gone too far this time.

The song for a post about fear had to be this one: