Lacy Hunt On The Unintended Consequences Of Well-Intended Policies

Tyler Durden's picture

Submitted by Lacy Hunt on behalf of Casey Research

Unintended Consequences of Well-Intended Policies

In the early 1960s, when JFK was in the White House and William McChesney Martin was Fed chairman, Keynesian economics was in full bloom. One of its major tenets is the Phillips Curve, which posits a stable inverse relationship between the rate of inflation and the unemployment rate. Yale professor James Tobin and others argued that the social outcome could be improved by a more activist monetary and fiscal policy. Specifically, they contended that the unemployment rate could be lowered while only resulting in slightly higher inflation.

The argument posited the notion that economic policymakers had sufficient knowledge to intervene or fine-tune the economy with tools like those of a surgeon. Presidents Johnson, Nixon, and Carter (two Democrats and one Republican) followed this policy. At one point, President Nixon made the famous statement that "We are all Keynesians now." Moreover, as the White House led, the Fed chairmen of the era – Martin, Burns, and Miller – generally acquiesced.

To judge the effectiveness of this policy, an objective standard is needed. Arthur M. Okun, Yale colleague of Tobin, developed such a standard, which he called the Misery Index – the sum of the inflation and unemployment rates.

Under the activist, Phillips Curve-based policy, some reduction in unemployment was temporarily achieved. However, inflation accelerated much more than was anticipated, and the net result was higher unemployment and faster inflation, an outcome not at all contemplated by the Phillips Curve. The Misery Index surged from an average of 6.7% in the 1950s, to 7.3% in the 1960s, to 13.6% in the 1970s, with peak rates above 20% in the early 1980s.

Many US households suffered. Wages of lower-paying positions failed to keep up with inflation, and when higher unemployment resulted, many of those people lost their jobs. Those on the high end had far more resources that enabled them to protect their investments and earned income, so the income/wealth divide worsened. A half-century later, the United States has never regained the prosperity of the 1950s.

Working independently in the late 1960s, economists Milton Friedman and Edmund Phelps, who would both eventually be awarded the Nobel Prize in economics, had determined that while the Phillips Curve was observable over the short run, this was not the case over the long run. While the economics profession debated the Friedman/Phelps research, the US had to learn its findings the hard way.

Growing Evidence of the Long-term Depressants from Activist Policies

In addition to the compelling evidence that more active monetary and fiscal policy involvement did not produce beneficial results over the short run, three recent academic studies, though they differ in purpose and scope, all reach the conclusion that extremely high levels of governmental indebtedness diminish economic growth. In other words, deficit spending should not be called "stimulus" as is the overwhelming tendency by the media and many economic writers.

Whereas government spending may have been linked to the concept of economic stimulus in distant periods, these studies demonstrate that such an assertion is unwarranted, and blatantly wrong in present circumstances. While officials argue that governmental action is required for political reasons and public anxiety, governments would be better off to admit that traditional tools only serve to compound existing problems.

These three highly compelling studies are:

  • Debt Overhangs: Past and Present, by Carmen M. Reinhart, Vincent R. Reinhart, and Kenneth S. Rogoff, National Bureau of Economic Research, Working Paper 18015, April 2012;
  • Government Size and Growth: A Survey and Interpretation of the Evidence, by Andreas Bergh and Magnus Henrekson, IFN Working Paper No. 858, April 2011;
  • The Impact of High and Growing Government Debt on Economic Growth – An Empirical Investigation for the Euro Area, by Cristina Checherita and Philipp Rother, European Central Bank, Working Paper Series 1237, August 2010.

These papers reflect serious research by world-class economists from the US, Europe, and Sweden – and they all confirm the detrimental consequences of extreme governmental indebtedness.

Misery on the Rise Again

In the past year, Okun's impartial arbiter averaged 10.5%, the highest on record for the third year of an officially recognized economic recovery and almost double the average of the 1950s. The latest readings have occurred despite US gross public debt in excess of 103% of GDP and with the Federal Reserve's unprecedentedly large balance sheet that approaches nearly $3 trillion.

Other measures of well-being confirm the Misery Index. The Poverty Index in 2011 appears to have reached 15.7%, the highest reading in five decades. Not surprisingly, two unenviable records have been set: 46 million, or 14.6% of the population, are now in the food stamp program, up from 7.9% in 1970 and a record-high 41% pay zero national income tax.

In the eleven quarters of this expansion, the growth of real per-capita GDP was the lowest for all of the comparable post-WWII business cycle expansions. Real per-capita disposable personal income has risen by a scant 0.1% annual rate, remarkably weak when compared with the 2.9% post-war average. It is often said that economic conditions would have been much worse if the government had not run massive budget deficits and the Fed had not implemented extraordinary policies. This whole premise is wrong.

In all likelihood the governmental measures made conditions worse, and the poor results reflect the counterproductive nature of fiscal and monetary policies. None of these numerous actions produced anything more than transitory improvement in economic conditions, followed by a quick retreat to a faltering pattern while leaving the economy saddled with even greater indebtedness. The diminutive gain in this expansion is clearly consistent with the view that government actions have hurt, rather than helped, economic performance. Sadly, many of those whom the government programs were supposedly designed to help the most have suffered the worst.

The Way Out

The original theoretical argument in favor of deficit spending originated in J.M. Keynes' The General Theory of Employment, Interest and Money. A search of Keynes' work reveals no recognition of the "bang point," or the condition where a government engages in deficit spending for such a prolonged period of time that a massive buildup of debt leads to denial of additional credit to the government because of fear that the existing debt will not be repaid. Nor did Keynes address the situation where a large number of countries are all simultaneously getting deeper and deeper in debt and there are gradations of debt among these countries – serious shortfalls in the basic Keynesian theory.

Keynes, as opposed to some of his interpreters and predecessors, may have implicitly recognized that a bang point could occur, because he did not recommend constant budget deficits. Instead, he advocated cyclical deficits, counterbalanced by cyclical budget surpluses. Under such a system, government debt in bad times would be retired in good times. However, Keynes' original proposition was bastardized in support of perpetual deficits, something Keynes himself never advocated.

Milton Friedman, whom many consider to have been the polar opposite of Keynes, also never addressed the concept of a bang point, but he may also have understood implicitly that such a situation could occur. The reason is that Friedman advocated balanced budgets, which if followed or required constitutionally as Friedman argued, would prevent a buildup of debt. This view was largely rejected as being inhumane since in a recession, government policy would not be responsive to unemployment and other miseries of such a condition. What should have been discussed is whether some short-term misery is a better option than putting the entire country and economic system in jeopardy, as numerous examples in Europe currently illustrate.

The most sensible recognition of budget policy came not from Keynes nor Friedman, but from David Hume, one of the greatest minds of mankind, whom Adam Smith called the greatest intellect that he ever met. In his 1752 paper Of Public Finance, Hume advocated running budget surpluses in good times so that they could be used in time of war or other emergencies. Such a recommendation would, of course, prevent policies that would send countries barreling toward the bang point. Countries would have to live inside their means most of the time, but in emergency situations would have the resources to respond.

In the context of today's world, this approach would be viewed as unacceptable because it would limit the ability of politicians to continue their excessive spending, thereby saddling future generations with obligations and promises that cannot be honored. But isn't Hume's recommendation exactly what we teach our children in preparing them to manage their own personal finances?

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fonzannoon's picture

Well intended my anus.

jeff montanye's picture

oh well, i might as well jump in as look up uranus.

this post is noteworthy, imo, because it gives keynes his due, at least.  he did say that governments should run surpluses in times of plenty (hear that ghost of reagan and, i wish, of bush jr.?).

he was not unique in that insight.  good princes in the era before we (as a species) forged iron, knew that resources should be husbanded (or, much more likely, wifed) in good times to have stores in times of famine.

unfortunately, we have evolved a political system which depends on those having a stake in the matter putting a stake in our hearts to succeed.

F-X's picture

The poster was referring to the title -- On the unintended consequences of well-intentioned policies.

Clearly the policies are intended to preserve politicians' jobs - nothing more, nothing less.

Michael's picture

Just wait till the adjustable rate mortgage on America's $16 trillion debt goes up. Must see new Rick Santelli & co video.

NotApplicable's picture

Psshaw! Debt service costs are for the little people.

Any attempt at forcing sovereign rates higher is merely a squeeze in order to get them to "play ball" with the globalists.

If you want to see fireworks, just wait until everyone's variable interest rate on the credit cards goes through the roof. Total debt load is somewhere around $1T.


economics9698's picture

Y = C+ I - G + NX

Economics 101.

Fiscal policy.  When the Feds spend more than 18% of the GDP there will be a deficit 98.5% of the time.  The bigger the deficit the shittier the economy.  Exhibit A, 2009-2012.

Monetary policy.  The Feds print for their friends on Wall Street and bribe the politicians in Washington.  It s a big criminal organization, the more they print, the more they steal, the worse off the people are.

End of lesson.

All the economists above are government employees in one sense or another and are paid propagandist for the fascist regime.  Do not listen to them, they are full of shit.

Any questions?  

slyhill's picture

What can should will I do?

mkhs's picture

Don't worry.  Seems Obama has given everyone a pass.  You (everyone) didn't build the debt.  It is not your fault or responsibility.

jeff montanye's picture

yes, you are funny with the -g.

it is so sad that the current government is so captured by the capitalist pigs, to coin a phrase.  

the unions are a joke or an invisibility.  

where will you (we) turn?

i have no pat answers, only (ridiculous) portfolio recommendations.  p.s. i like majestic silver and oppenheimer and van eck gold funds but don't set any store by that sh8t.  if you have no sense at all, double short the treasury and the equity markets. 



Stuck on Zero's picture

Very well intended for the 0.001%.  They are 31 Trillion dollars richer and have protected their wealth in tax havens, yachts, land, and captive government officials.


Beam Me Up Scotty's picture

"Well intended my anus"

That is exactly it.  It has nothing to do with "well intended".  Its all about buying votes for politicians.  Everything they think or do or say is about buying votes.  Our whole tax code is created to buy votes from people.  Be they rich or poor or middle class.  These idiots don't give a shit about unemployment.  In fact some politicians love it because they can use it to buy votes.

Thats the problem in one simple nutshell.

traderjoe's picture

No, the tax code was created to ensure your debt servitude to TPTB. Sovereign countries don't have to borrow "money", at interest and with the collateral of your future labor. The sovereign governments, for free, have granted the right to create money (under fractional reserve banking) to the commercial banks. These banks can create money out of thin air and lend it to the government, once again - at interest. See the United States Note. 

That's simply the scam of the century. 

No taxes are required by sovereign governments. It's no coincidence that both the Federal Reserve and the Income Tax were created in the same year. 

Beam Me Up Scotty's picture

Its both.  They vote buying keeps the whole process going.  Heres a for me.

Quisat_Sadarak's picture

You have my vote.

...phasers on stun, Kirk out.

bob_dabolina's picture

I have an idea.


Once they're all dead everyone can welfare themselves.

AlaricBalth's picture


You have been designated a malcontent and are now considered a threat to National Security of the United States of America. The Stellar Wind Worldwide HydraSquid Algorithm has detected an anomaly from your IP address and hereby orders you to surrender yourself to the nearest law enforcement agency. A Skynet airborne drone has been dispatched to your location coordinates to ensure compliance with this directive. Upon your voluntary arrival at LEA, you will then be relocated to one of the DHS re-education facilities in an undisclosed location.

This is the only notice you will receive.
Resistance or non-compliance will be met with extreme prejudice.


francis_sawyer's picture

The pride of Manhattan... (in the FILA tennis shirt with no bra)...

NeedtoSecede's picture

"He says to me: Gunga La Gunga: On your death bed you will recieve eternal consciousness.  So I got that going for me..."

Thanks ZH for giving some of us financial outsiders a chance to look behind the curtain and see the scam.

SilverDoctors's picture

Tyler- CME just slashed silver margins 11% after the close.  Big move tomorrow w/ the BLS?

fonzannoon's picture

After last year if you buy silver on margin you should get a free helmet.

SilverTree's picture

Turd is hoping for a nice pop tomorrow too. Phyz and only Phyz my friends.

fonzannoon's picture

My guess is we get a number above 110k tomorrow. QE is off the table for now so we have to have some data points for the fed to ponder.

SilverTree's picture

Anything and everything will be done to push the shitstorm beyond the elections. Think of the power grab during the epic flush. Prepare if you dare!

SilverTree's picture

Ripped from treefrog @TFMR


"tired of all the more common patterns like head and shoulders?  check out the netdania one minute silver spot chart right now.

it's the rare "lingering dog fart pattern. "

somebody who knows how to post a screen capture from netadnia to here, please post it!

this pattern has a high probability of predicting a move either up, down, or sideways!"

Neethgie's picture

so then you can hold it and try and feel its value disintegrate.

NidStyles's picture

Hmm, nope all 31.1 grams per Troy oz. are still there. 

NotApplicable's picture

Mr. Celente approves of this message.

RacerX's picture

or at least a 32oz tub of K-Y

TheSilverJournal's picture

Silver probably won't go anywhere fast for a few weeks. Tremendous upward pressure in the long run, but too much downward pressure right now with scares of the ESM and Eurobonds not going through and the Fed not stepping up its purchases. Then they approve ESM and ease further and it's off to the races.

But who knows, even though the market might sell off hard, there's so much upward pressure on silver right now that it may not sell off with the market and might just go up anyway.

flacon's picture

Sounds like you've got your bases covered. ;)

RacerX's picture

He should start a newsletter.

TheSilverJournal's picture

Silver's only going to $1,000 / oz in real terms over the next few years. No biggie.

NotApplicable's picture

If they keep killing off the FCMs, paper silver may stay low for a long, long time. Physical, meanwhile, will simply not be available at that price.

TheSilverJournal's picture

You can't expect good results when the decisions to control the monetary system is made by a few guys behind closed doors.

MsCreant's picture

Preaching to the choir posting that here. Good post to pass on to others though. Very straight forward.

RockyRacoon's picture

I don't know about you Missy, but I've given up on elucidating others about these matters.  Can't find a one who gives two shits.  The ones who connect are already in the loop.   It's sad that I gotta run most of my friends off when they show up on my front porch looking for a handout.

Urban Roman's picture

Which I find amusing, given your avatar. I have had tho shoo your kind off of my front porch!

RockyRacoon's picture

Yeah, and you've been dead for 2,000 years -- give or take.

francis_sawyer's picture

Well ~ the useless emperors stage still seems to be alive & kicking...

nmewn's picture

(Ribs hurting from laughing)...thanks Rocky.

NeedtoSecede's picture

I am on an airplane catching up on my fix of ZH and I am laughing so hard I am getting strange looks from everyone within earshot.  Well, actually, I always get strange looks, but today more than ever.  It is hard not to laugh when the first comment out of the blocks contains the word anus.  And it just gets better from there.

Love ZH and love the comments!

MsCreant's picture

Can't give up Rocks. I have a bully pulpit.

Neethgie's picture

i have always thought that if you run a surplus during the good times without debt, you can have a party should the bad times show up.

unfortunately you cant run a mild deficit during the good times, then go full retard on it during the bad times as we see now, the problem lies with politicians more intent to hold office than use office of course they will spend whatever they can because its a vote winner, even though its stupid but who cares about tommorow? also with that excess spend you are pumping the economy with steroids that shouldnt be in play causing an even worse reaction when instead of spending the gov has to cut back too. 

by going full retard we now have no bazooka we have spent it all, now the crash is bigger than if we had a few spare pennies to stabilize things.

RockyRacoon's picture

Congress is like a little kid getting his tiny allowance.   He runs down to the corner candy store and spends all he has on what he can.   Then in the middle of the week he looks longingly at the items that would take 3 allowances total to buy.  But wait!  Congress can borrow!  Problem solved.  All those immediate gratification desires can be satisfied.

disabledvet's picture

You are clearly a sensible person. I SALUTE YOU! Having said that "we've gone from the asshole rich to asshole Government." in other words "nothing succeeds like excess" and...well, I just didn't see "trillion dollar deficits plus a debt downgrade" being a net net positive. I will listen intently to Bill Gross tomorrow cuz "this ain't just Confounded Interest" here...clearly we're full on "lunatic fringe-enomics." unless and until someone can explain to me how "Keynes on Planet Pluto" (which is what we have) can possibly work I'm just not listening. I mean "Japan like interest rates with full on Imperial Overlord" shit. How does that friggin work?

Whiner's picture

I like to blow the balloon, way, wayyyyyy up! Then she goes "POP" real lound and quick! What's fun is the balloon can get soooo big and then "BANG!!!" just when you think she'll take a few more blows. Then it really scares the crap out of everybody!