A Libertarian Perspective on
Economic and Social Policy
Lecture 16
Economic Stability and Growth
©2009 Jeffrey A. Miron
Introduction
• Traditional libertarianism is most often associated with
microeconomic issues, and the standard libertarian
insights might seem better suited for addressing those
kinds of policies.
• Macroeconomic policies are important too, however;
– These policies affect the entire economy, so the potential for
benefits or costs are greater than for many micro policies.
– And, bad economic times often give rise to bad economic
policies generally.
– So, even libertarians might consider intervention to improve the
overall functioning of the economy if this intervention works and
promotes better policies in other areas.
• This lecture examines a range of macroeconomic
policies from a libertarian perspective.
Introduction, continued
• Despite the fact that issues of “rights,”
externalities, and the like are less obviously
relevant for macroeconomic issues, I will
suggest that the version of libertarianism I have
presented in this course – thoughtful cost-benefit
analysis – is just as useful for examining macro
policies as it is for examining micro policies:
– And this approach leads to similar conclusions:
– Most interventions do more harm than good.
Outline
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Stabilization Policy
Deficits
Central Banks and Money
Fixed Versus Floating Exchange Rates
The Exchange Rate as a Target
The Balance of Trade
Free Trade
Immigration
Foreign Aid
Stabilization Policy
• Until the Great Depression of the 1930s, the
focus of most economics was micro:
– The idea that the overall economy could suffer a
general, coordinated decline was not given much
attention.
– Instead, analysis addressed the behavior and failures
of individual markets, assuming that with a large
number of individual markets, some growing and
others declining, overall economic progress would be
reasonably steady, and any fluctuations would reflect
exogenous, unavoidable events such as weather or
disease (e.g., the bubonic plague).
Stabilization Policy, continued
• The Great Depression changed this view:
– Many economists concluded that capitalist economies
could suffer substantial, prolonged downturns from
which they would not quickly recover on their own.
• Macroeconomists therefore developed two
things:
– A theory of cycles and recessions (based on sticky
prices);
– A theory of how policy could reduce or eliminate
these cycles, i.e., stabilize the economy.
Stabilization Policy, continued
• This perspective became the accepted
framework in both academic and policy
circles.
• The framework suggests that monetary
and fiscal authorities should adjust money,
interest rates, taxes, and spending in a
countercyclical fashion.
• The goal is to smooth out the fluctuations
in aggregate output.
Problems with Stabilization Policy:
The Lags are Long and Variable
• A basic problem with stabilization policy is
that it affects the economy with a lag:
– This is partly because it takes time to
recognize that the economy is going into a
recession;
– This is partly because it takes time to choose
and implement an appropriate policy;
– This is party because it takes time for the
chosen policy to affect the economy.
Long and Variable Lags,
continued
• The lags would not be an issue if forecasting were easy
and if the lags were of fixed or highly predictable length:
– Under these assumptions, policymakers can simply start
adjusting policy in anticipation of an expected downturn, thereby
smoothing out the cycle.
• In practice, however, forecasting is an inexact science,
and the lags in policy are long and variable.
• Thus, attempts at stabilization can easily be counterproductive, i.e., destabilize the economy.
– The evidence on whether policy has stabilized or destabilized
does not make a compelling case in either direction.
– But it certainly fails to indicate that policy has on average been a
stabilizing force.
Aside: What did We Learn from the
Great Depression?
• The Great Depression was regarded at the time as proof
that economies are inherently unstable and that
stabilization policy is needed.
• In fact, later research (Friedman and Schwartz’s A
Monetary History of the United States) argues that a
modest recession became the Great Depression
because the Fed allowed the money stock to fall
substantially:
– Thus, F&S claim the Great Depression resulted from bad policy,
rather than being evidence that active policy is desirable.
• There is a range of opinion among reputable economists
about the FS hypothesis.
– But few deny the possibility that policy contributed substantially
to the outcome.
Long and Variables Lags,
continued
• A possible response to the long and variable lags is that
policy should attempt to stabilize, but cautiously:
– That is, only take action in response to large, obvious shocks,
rather than attempting to fine-tune.
– In fact, there is no longer much support for fine-tuning, despite
continued support for some degree of activism.
• A second possible response is that, over time, the
uncertainty about policy and the difficulties in forecasting
will diminish;
– Plus, there will be learning by doing, so it’s useful to practice.
• These arguments are not totally silly, and if there were
no other costs to stabilization policy, they might be
persuasive.
• But there are substantial other costs.
Problems with Stabilization Policy:
Is Smoothing Desirable?
• A potentially important problem with stabilizing
the economy is that some fluctuations might be
at least partly efficient.
– If oil prices rise, it might be good for the economy to
invest in coal-burning technology; in the short run, this
reduces growth.
– If a new technology like computers arrives, the
economy might slow in the short run as it adopts the
new technology.
• This is the Real Business cycle view; if it is even
partly right, then smoothing might have a cost
especially when successful.
Problems with Stabilization Policy:
Growth versus Stabilization
• A related problem with the focus on
stabilization policy is that it distracts from
thinking about growth:
– There is a reasonable case that the benefits
of even slightly faster growth swamp any
benefits of reduced fluctuations.
– The stabilization view therefore encourages
thinking about the less important issue.
Problems with Stabilization:
Adding Uncertainty
• A different effect of stabilization policy is that
the private sector expends resources forecasting
what policy is going to do, instead of just
forecasting what the economy is going to do.
• This is wasted effort; the extra uncertainty
complicates life for the private sector.
• Indeed, there is a plausible case that some
instability arises from the private sector trying to
figure out what policy is going to do, rather than
from inherent instability.
Problems with Stabilization Policy:
Microeconomic Considerations
• One standard tool of stabilization policy is increased or
decreased deficits:
– Cutting taxes or raising expenditure expands the economy, and
vice versa, so policy can attempt to offset fluctuations by
adjusting taxes or expenditure.
• The problem is that taxes and expenditure have
microeconomic implications, independent of any impacts
on stabilization. That is,
– Deficit = G – T
• And we should care about the levels and composition of
G and T separately, not just the difference.
• It is possible that policy should consider both effects:
– But it certainly should not ignore the micro side.
Deficits and Debt
• The conventional view of budget deficits and government
debt is that these are bad things:
– In particular, the standard claim is that when the
government runs a deficit it must borrow from the
public, which raises interest rates and crowds out
private investment.
• This view is reasonable, but it is not the only possible
scenario:
– Under Ricardian equivalence, deficits have no effect.
• Existing evidence suggests the U.S. economy is somewhere between the extreme views.
Deficits, continued
• How should libertarians feel about deficits?
• The first reaction should that expenditure is too
high in most economies and should be reduced,
independent of the deficit.
– If this occurs, deficit issues become moot.
• A second reaction might be that, even if
expenditure is not cut right away, “starving the
beast” helps control expenditure over time:
– Thus, (virtually) all tax cuts are a good thing, even if
they raise the deficit.
– In fact, the evidence does not support STB.
Central Banks
• If stabilization policy is undesirable, is there a
good reason for a central bank?
• No.
– Once a central bank exists, it will intervene.
– The only intervention that is necessary in connection
with “money” (i.e., the means of payment) is that
government must establish what form of payment it
accepts in those transactions it conducts.
• This may establish a default “money.”
• But everything else can be done privately.
• Note that the U.S. got along quite well without a
central bank until 1914.
Fixed Versus Floating
Exchange Rates
• A different macroeconomic question that
economies confront is whether to have a
fixed or floating exchange rate.
• Eliminating the central bank does not
avoid this issue, since Treasuries can and
do attempt to “peg” exchange rates.
• And it’s an important question for countries
that do have central banks.
Fixed Versus Floating
Exchange Rates, continued
• This is an easy issue:
– There is no sensible case for fixed rates.
• The negative things people associate with
exchange rates (e.g., currency crises) can only
happen under fixed rates:
– Under floating, the rate simply adjusts to changes in
the demand and supply, just like for any other good.
• Moreover, much of the uncertainty about
demand and supply occurs because of
fluctuations in government policy toward
exchange rates and related issues.
The Exchange Rate as an
Independent Target of Policy
• A related question is whether policy should care about
the level of the exchange rate:
– For example, yuan is undervalued because China is
trying to stimulate its exports.
• We should not care if China wants to subsizie its
exports:
– That just makes their goods cheaper for us.
• It is misguided for China, or any country, to pursue such
export promotion policies:
– Same criticism as any “industrial policy.”
– Markets, not governments, do the better job of
deciding which goods to produce.
• So, policy should take no stand on the exchange rate.
The Current Account Deficit
• In addition to worrying about the exchange rate,
countries worry about current account deficits.
• The balance of trade of any country is the record
of all its transactions with the rest of the world.
• This balance of trade has two pieces:
– The current account, which records trade in goods
and services. It equals exports minus imports and is
often referred to as net exports.
– The capital account, which records trade in assets.
The Current Account Deficit,
continued
• An inescapable fact of accounting is that the
balance of payments always balances:
– CA + KA = 0.
– In words, if I buy a bottle of wine from France, the
U.S. has a CA deficit but an offsetting KA surplus:
– Goods flowed into the U.S. but an asset (the dollars I
spent on the wine) flowed out.
– NB: if I first bought francs from France, that was a
wash in the KA.
• The CA and KA do not necessarily balance
individually and in fact are zero only rarely.
The Current Account Deficit,
continued
• The question is, should a country care whether its CA is
positive or negative?
• If the CA is negative, it means the country is borrowing
from the rest of the world.
– There is nothing inherently bad about that.
• A CA deficit might be a reflection of underlying problems:
– A CA deficit occurs when domestic saving is low.
• So, if there are policies that inappropriately discourage
savings, it makes perfect sense to undo those.
– But this would be true in a closed economy.
– The CA deficit plays no independent role.
Free Trade
• Of all the propositions in economics, the view that free
trade is best is perhaps the most widely held. And for
good reason:
– Barriers to trade such as tariffs or quotas reduce or prevent
Pareto-improving exchange;
– And trade has additional benefits, such as providing competition
for domestic industry.
• Are there reasonable arguments for restrictions?
– In theory, perhaps, but in practice, no.
• This does not mean trade is always good for everyone:
– It adversely impacts low-skill labor in high-wage countries.
– But it also helps low income workers through standard channels,
and it makes more sense to redistribute directly, if warranted.
Free Trade, continued
• The libertarian view, therefore, is that any
country with trade barriers should remove them,
unilaterally and immediately.
• The one possible argument against this
approach is that, by threatening to retain its
trade barriers, a country like the U.S. might
convince other countries to reduce theirs.
• This is possible in principle:
– In practice, it simply seems to be an excuse for further
delay in removing existing barriers.
Immigration Restrictions
• Until the end of the 19th century, the U.S.
had virtually no regulation of immigration.
• During the early 20th century, there was
some regulation and a few notorious
restrictions enacted (in particular, the
Chinese Exclusion Act of 1882).
• But overall, immigration was barely
regulated by today’s standards, and
immigration rates were high.
Immigration Restrictions, continued
• In the early 1920s Congress enacted a quota system
based on national origin; this reduced immigration
dramatically through the 1950s.
• In mid-1960s, further modifications gradually eliminated
the quota system and simply set limits on numbers of
immigrants.
• Over the past several decades this system evolved
further.
– Now, immigration is allowed mainly because of family
connections, labor market skills, or refugee status.
– The total amount of legal immigration is modest by historical
standards; roughly a third the rate (relative to population) of the
early 20th century.
Immigration
• Most (rich) economies restrict immigration
substantially.
• There is no good efficiency argument for this; in
fact, restrictions reduce global efficiency.
• The only argument is distributional:
– Existing low-wage workers are likely to lose out as a
result of immigration, which fits with the fact that
unions and other low-wage groups strongly oppose
relaxed immigrations restrictions.
Immigration, continued
• The libertarian position is that income effects are best
addressed, if at all, using other policies such as an NIT.
• Thus, libertarians tend to favor eliminating all barriers to
immigration.
• The only possible caveat is that one significant group of
beneficiaries – the immigrants – are not (yet) citizens or
residents of the country allowing the immigration.
– So, some would argue they deserve less weight in the social
welfare calculation.
• If there were no costs of immigration restrictions, this
might be a tough issue.
• But there are such costs.
Costs of Immigration Restrictions
• Like all prohibitions, those on immigration
generate black markets, with all the standard
negative effects:
–
–
–
–
–
Violent dispute resolution
Disrespect for the law
Rewarding the relatively dishonest
Corruption
Reduced “product quality”
• Plus, there are direct costs of enforcement.
Immigration and Security
• A different argument for restricting immigration is
that this is necessary to “keep out terrorists.”
• But the restrictions do not work particularly well:
– Tons and tons of illegal drugs enter every year
– Hundreds of thousands of illegal immigrants enter
every year
• It is hard to see how a determined terrorist is
affected by any enforcement regime we can
imagine.
Foreign Aid and Lending
• In addition to trying to manage their own
economies, some countries (the rich ones)
attempt to manage developing economies.
• The main mechanism is organizations like
the IMF and the World Bank, which lend to
poor countries “conditional on” adoption of
the “right” economic policies.
Foreign Aid and Lending, continued
• This policy sounds sensible in theory; the
practice is much tougher.
• First, stabilization policy is difficult at best, as
discussed above.
• Second, ensuring that the recipient countries
follow these policies is hard.
• Third, there is much scope for diversion of the
funds to bad purposes.
• Fourth, the incentives of the IMF, WB are to
keep making loans, not to be “tough.”
Foreign Aid: Grants
• It might seem that even if rich government
lending to poor countries is problematic,
unrestricted grants cannot help but make the
recipient countries better off.
• In practice, there is no evidence that foreign aid
helps.
• This might seem counterintuitive, but there are
plausible explanations.
• Most importantly, the availability of “free money”
provides an excuse for not adopting good
policies, most of which countries could do on
their own.
Conclusions
• Eschew active stabilization policy.
• Choose spending levels and tax programs
based on efficiency considerations.
• Eliminate the Fed; fix the money stock at
whatever it is now (or adopt a rule).
• Let the exchange rate float.
• Ignore the exchange rate and the CA deficit in
making policy.
• Free trade, unrestricted immigration.
• Leave other countries alone.