Big deficits and easy money have failed

Investors around the world are rattled at the recent plunges in the U.S. stock market. Keynesian pundits predictably blamed our economic woes on the (nonexistent) austerity measures in the recent budget compromise, saying we just need more deficits and a looser Federal Reserve. But in reality, it is unprecedented budget deficits and money-creation that have dug us into this hole.

To understand how immense our doses of Keynesian “medicine” have been since the crisis began in the fall of 2008, we need historical perspective. It took two centuries — from the founding of the Republic until 1981 — or the federal government to rack up its first trillion dollars in debt. In contrast, the most recent trillion dollars in debt were added in the past nine months.

In 2008, the official federal deficit was a record-setting $642 billion. By the next year, it had more than doubled to $1.55 trillion. By 2010, it had fallen to a mere $1.37 trillion, and for 2011 it is projected to set a record of around $1.65 trillion. That means about 32 percent of the current $14.3 trillion total federal debt has been added in just the past three years.

When it comes to monetary policy, things are even worse. The “monetary base” is the smallest aggregate that economists use to measure the money supply, and includes the actual currency held by the public as well as reserves held by commercial banks. The monetary base is the best single measure of whether the Federal Reserve is being expansionary or contractionary, because the Fed directly controls this aggregate.

From the Fed’s founding in 1913 until August 2008, it allowed the monetary base to grow to $872 billion. In the three years since, the Fed has tripled the monetary base to more than $2.7 trillion. About 68 percent of the total monetary base in the economy has been added in just the past three years.

Proponents of the free market can readily understand the harm of these unprecedented interventions.

Government fiscal deficits divert resources away from the private sector and direct them toward political channels. Monetary intervention — particularly when used to bail out politically connected investment bankers — artificially pushes down interest rates and interferes with the price system’s ability to allocate resources and launch a true recovery.

Starting under George W. Bush, and ramped up under Barack Obama, the federal government has engaged in the largest domestic spending spree to foster economic recovery since the New Deal. The last time the government grew so rapidly, the country was mired in a depression for a decade. We are almost halfway there ourselves.

Rather than persisting in the same reckless and failed approach, it’s time for policymakers to cut taxes, cut spending, cut regulations, and let the free market create jobs. It works every time it’s tried.

Robert P. Murphy is a senior fellow in Business and Economic Studies at the California-based Pacific Research Institute.

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