Classical economic policy and the present recession

Whatever anyone might believe about the dangers of the Corona Virus, there is no doubt that the American economy, in fact every economy, is heading into recession. There will be a large fall in output and a rise in the rate of unemployment. All this is inevitable. But what must be understood if policy is to achieve a positive outcome is that the downturn cannot be understood as due to a fall in demand as modern economic theory would have it, but will be due to a massive structural shift in our economies. It is not that we will be buying less because we are saving more, but we will be buying not just less, because we will be producing less, but we will not be buying many goods and services we had been buying until concerns about the virus became so general. Lots of forms of production, such as air travel and restaurant meals, will experience a major contraction in demand because of the fears that certain activities are now forbidden or many people have self-isolated.

As every pre-Keynesian economist once knew,  recessions do occur but NEVER because a deficiency of demand. When they occur, they are the result of a structural shift in the underlying economy. We are now in the midst of one of the most profound shifts in the international economy ever seen. Just the restaurant trade is facing a major fall in demand, along with airline travel, tourism and lots of other parts of the economy. The structure of the economy is under immense stress. The downturn which is inevitable is due to a structural shift, not a fall in demand. Everyone once understood that. Since 1936, since the publication of Keynes’s General Theory, this then-universal understanding of why recessions occur has disappeared utterly from economic discourse. I used to think the pre-Keynesian conception was obvious, but have discovered to my amazement that virtually no one any longer understands it. We are all Keynesians now, except for a handful of others who have retained this older, now abandoned, approach. But what has amazed me now even more is that the approach taken by Donald Trump in trying to deal with the coming downturn clearly takes a classical approach to softening the economic fall-out that is now inevitable.

Nothing will prevent a downturn now, but what must be done is:

(1) ensure those who are now being temporarily displaced from their paid employment are receiving cash in hand so that they can buy what they need,

(2) businesses, whose revenues will be falling and in many instances be reduced to zero, must have an immediate fall in production costs through perhaps cuts to various forms of taxation, along with receiving cash injections so that businesses which will return to profitability after this disruption are able to maintain at least part of their cash flow and pay their bills, not just so that they can stay in business but that so too can their suppliers

It is the structure of demand that needs to be preserved, not the level. The level of demand will fall, but the crucial issue is that the structure of demand will also be badly affected. The aim of policy must be to ensure that the underlying structure of supply is maintained. This is what is meant by supply-side economics. It is to maintain the structure of the economy that matters. Maintaining the structure is crucial, not the totality. Demand is constituted by supply, and supply will be falling all over the place and therefore so to will demand.

See the airline industry as a clear example. People will one day wish to fly as they have always done, but the airlines must be preserved in the meantime. Virtually every industry is in exactly the same position. No revenue or drastically reduced revenues at the moment to meet their costs, but also with a certain expectation that demand will return in the near future. The aim must now be to preserve as much as possible.

The photo above was taken while watching Fox with the proposed government approach stated as follows:

RPT:PROPOSED GOVT STIMULUS PKG WILL INCLUDE $1200 FOR SINGLE AMERICANS AND $2400 FOR COUPLES

As we think of things today, it has to be presented as a “stimulus” as if the aim is to raise the level of demand. It is, nevertheless, an approach to dealing with a structural shift in the economy, and the aim is to preserve as much of the economy as can be preserved for when things return to normal. The policy proposal is discussed here: GOP coronavirus stimulus bill unveils $1,200 checks for public.

“Recovery checks of up to $1,200 will be put into the hands of most taxpayers, providing cash immediately to individuals and families,” the Senate Finance Committee said in a statement.

President Trump requested that the legislation include the direct payments to boost consumer purchasing. The White House requested two $1,000 waves of checks to all taxpayers.

On the business side, there is also this:

The package also includes $300 billion in small business loans, which would be forgiven if the firms don’t lay off workers.

Another $58 billion in loans would go to airlines suffering a demand plunge worse than after 9/11, with another $150 billion of loans and loan guarantees to other businesses.

This is obviously also intended as a means to maintain the structure of the economy, not as a “stimulus” to lift demand. Among the good luck of the moment is that the President is a former businessman who understands the problems facing business and what needs to be done immediately to minimise the long-term harm to the economy. I can only hope the same approach is taken across the world.

Having just finished the first round of editing of my next book, Classical Economics and the Modern Economy, let me recommend it to one and all once it is finally published in June. It is even possible that classical economic theory may once again come back into fashion. The benefit to our economies and future standard of living would be massive.

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29 Responses to Classical economic policy and the present recession

  1. NoFixedAddress says:

    Steve

    You got a Guernsey at Power Line ‘Picks’ for this post

  2. Caveman says:

    Have the government announce that they will cut all personal and company tax across the board. Borrowing money to fund a business with no customers won’t make sense.

  3. gary says:

    Stock market keeps falling like this it will be back at its true value in a few weeks. Housing market might go the same way.

  4. Iampeter says:

    But what has amazed me now even more is that the approach taken by Donald Trump in trying to deal with the coming downturn clearly takes a classical approach to softening the economic fall-out that is now inevitable.

    Except that’s the exact opposite of what’s actually happening.

  5. Watch Your Back says:

    Yes, it’s not a problem of ‘aggregate demand’. It’s a problem of liquidity as firms lose business and people lose jobs and income.

    I wouldn’t characterise this as a structural shift either, more of an external shock that has not originated with any shift within economies. It’s like a war or the oil crisis in 1973, a political act.

    The UK Chancellor has just announced that the government will pay people at risk of losing their jobs 80% of their income. This is a temporary, emergency measure designed to keep businesses and industries from collapsing. It should, as you argue, keep the supply side from simply disappearing. It’s not a ‘stimulus’ in Keynesian terms, the BBC has decided it is. Neither is it Socialism.

    When the economy starts growing again, indeed in the run up to growth, there will be an opportunity to recast taxation, corporation tax, award rates and penalty rates. Perhaps even a flat tax? We could perhaps dump Keynesianism for good.

  6. mundi says:

    This recession will be caused by goverment intervention only.

    If you look at the actual consumption that has dropped, its all been mostly frivolous things, like holiday travel. The consumers are saving more.

    I would nearly go so far as to argue that there would have been no recession at all, as the avoidance of wasteful consumer spending would have lead to increased investment and better overall production.

    Now of course, every excuse in the book will be used for the government to go into massive debt, and inflate away every cent of credit any one dumb enough to save has.

    My bet is that the RBA and Government will start printing money, anything to see inflation back up at 3% and prices going up and up. And it will just cause a fivcious cycle because the consumers will spend less and the government will bail out more. No one will look at or care about the level or production in society. Production isn’t even a word they know. You will not hear of it mentioned once anywhere.

  7. steve simmons says:

    I agree …. It is a supply re-structuring… However, it is also an election year so everyone is buying votes.. However, I was impressed with Sen Tom Cotton’s thought process over the pharma mfg bill. Further, Bloomberg proposed a major infra-structure spending bill. US money should focus on improving productivity and creating supply as globalization drops. The current bill focuses on increasing aggregate demand.

  8. bollux says:

    The RBA is pouring billions into keeping the banks capitalised and allowing mortgage holidays to keep the housing bubble inflated at all costs. I wish I was wrong but I think everything else is secondary.

  9. Alex Davidson says:

    If this long-winded sales pitch is anything to go by, I won’t be reading the new book. To me, classical economics is more of an explanation about how individual choice in a free market leads to prosperity. Yet here we have Kates recommending 2 days in a row that those ‘temporarily displaced from their paid employment are receiving cash in hand’.

    Why the use of the passive voice? Presumably Kates is implying that ‘the government’ is the source of these payments. But as we here on the Cat all should know, the government does not create wealth; instead it takes it by force or threat of force from those who do. So what Kates is suggesting is socialist redistribution of wealth, also less euphemistically known as theft, to address a problem created, not by the coronavirus as he suggests, but by unwarranted and draconian government restrictions upon our freedoms.
    Nothing to do with classical economics at all.

  10. Roger says:

    ensure those who are now being temporarily displaced from their paid employment are receiving cash in hand so that they can buy what they need,

    The UK appears to be well ahead of us on that, guaranteeing 80% of wages for those put out of work.

    Meanwhile, our government is debating subsidising the rugby league.

  11. Tel says:

    🚁💸 🚁💰 🚁💵
    💵🚁 💸🚁 💰🚁
    🚁💵 🚁💸 🚁💰

  12. Roger says:

    Yes, it’s not a problem of ‘aggregate demand’. It’s a problem of liquidity as firms lose business and people lose jobs and income.

    From the OT:

    25yo tradie son has no work as their raw materials come from Wuhan and have dried up.
    He’ll soon be broke, homeless, and unable to pay the loan on his ute.

  13. John Smith101 says:

    Good summary Steve, especially with regard to preserving demand structures. You might want to incorporate ‘gold standard’ in this thinking as well. Also debt forgiveness (recovery stimulus). While you are about it, Google NESARA (National Economic Security and Recovery Act). Much of what is happening will be found there. Also here: NESARA: GLOBAL CURRENCY RESET : Draining the Swamp (NESARA Act).
    Big things happening. Big Tech censorship is over (four days now, and holding). Good hunting and good luck.

  14. Spurgeon Monkfish III says:

    the government does not create wealth

    It can only destroy it.

  15. Watch Your Back says:

    So what Kates is suggesting is socialist redistribution of wealth

    The money comes from the economy, not the government, that’s is true. This is an emergency not caused by firms or employees. It’s a temporary injection to keep people from going under. Socialism never bothers to help people in this way, as we see in Venezuela.

    I think of this more as an insurance policy.If people pay taxes I think it’s right that we, via government, should help until the danger is gone. It’s certainly not Socialist redistribution!

  16. m0nty says:

    A post about the helplessness of classical economics in the face of a demand shock complete with a photo taken of a TV showing Fox News, probably taken with an iPad. This is peak Steve Kates. How much more Kates could it be? The answer is none, none more Kates.

    You can try to convince yourself that helicopter money for workers is in line with classical theory with a bunch of illiterate lies to yourself, but in the end you are on the same side as Wayne Swan and there’s no getting around that. There are no classical economists in foxholes.

  17. candy says:

    It’s a tragedy this has happened to America just when things were completely on the up and up.
    I don’t see Trump has much choice in his situation.

    Most governments seem intent on destroying their economy, being spurred on by personal fear of death.
    Possibly America will bounce back faster as their peoples seem more robust and positive, more go-getters. Not passive.

  18. John Bayley says:

    My bet is that the RBA and Government will start printing money, anything to see inflation back up at 3% and prices going up and up

    They have been printing for the past 40 years, and that program has been put on steroids since the GFC.
    If you don’t believe me, just look up the money supply (Mx) figures for the AUD. Broad money supply has exceeded population growth by some 7-8% annually, and has more than doubled in the past 12 years.

    That is the true inflation, not the BS they call the CPI index.

    Now add the QE the RBA has just announced – and promptly gone ahead with their initial bond purchase the very next day – and you can be certain we’ve seen nothing yet on the Ctrl+P front.

    Yet we have otherwise relatively sensible people on this blog (hello JC) who continue to think that somehow the central banks “need” to hit that magic “2% CPI” BS target and that they are “necessary” rather than being in fact, the very antithesis of the free market & socialist institutions & central planners to their very core.

    It can only destroy [wealth]

    I think you can safely drop the “can” from that sentence.
    Even so, in the “social media” dominated world of high IQ morons, the one thing we can be certain of will be clamoring for yet more and bigger government, because clearly “nothing else can save us!”

    The modern West – too stupid to survive.

  19. Gilas says:

    Honest question:

    I am clearly missing something here.

    How are Trump’s, and BJ’s “free” cash handouts any different to Krudd’s “stimulus” free $750 cheques in 2008-9?
    Today good, yesterday not good.

    A simple, polite explanation will be much appreciated.

  20. Iampeter says:

    How are Trump’s, and BJ’s “free” cash handouts any different to Krudd’s “stimulus” free $750 cheques in 2008-9?
    Today good, yesterday not good.

    It’s good when Trump does it and bad when Rudd does it.
    Conservatives aren’t really capitalists, they are just another tribe of socialists.

  21. John Bayley says:

    How are Trump’s, and BJ’s “free” cash handouts any different to Krudd’s “stimulus” free $750 cheques in 2008-9?

    Simple & polite answer:
    They are the same thing.

    Today good, yesterday not good.

    That’s partisan politics for you.
    Along the lines of “…the Liberals screw us silly, but Labor would be worse…so let’s continue voting for the LNP!”

    Doesn’t make much sense, I know. But those people are known as “rusted on” for a reason.

  22. max says:

    Basically for next 6-9 months until summer 2020 — we are all going to stay at home self isolated and government is going to send us pieces of paper money to continue buying food, paying rent, mortgage, electricity, hospital bills.

    I’m from the government and I’m here to help.

  23. candy says:

    It’s good when Trump does it and bad when Rudd does it.

    Iampeter, I suppose it might be the fear of death that is the difference driving it all.

    But I think the economic disaster could be far worse than the GFC.

  24. Gilas says:

    Thanks for the replies,

    As the thread creator par excellence here, it would be nice for Mr Kates to offer the ultimate economist’s explanation.

    Thanking Steve in advance…..

  25. John Bayley says:

    …it would be nice for Mr Kates to offer the ultimate economist’s explanation.

    LOL…which one would you like?

    “What happens when you put 10 economists in a room? You’ll get 11 opinions.”

    (Disclaimer: I think Steve is mostly one of the good guys, although he does have some peculiar blind spots, as others have observed on this forum.)

  26. Gilas says:

    John Bayley
    #3367311, posted on March 21, 2020 at 2:12 pm

    Hmmmyesss, a dismal science it is, after all.

  27. Watch Your Back says:

    Boris is not proposing sending cheques out, but Trump is considering it and Morrison has said he’ll do it. Boris is saying the uk government will pay people who lose their jobs 80% of their salaries up to £25,000.

    Rudd thought in terms of a ‘stimulas’ to prevent a technical recession. This also saw large spending programmes on Pink Batts, school halls and the NBN.

    Boris is paying people in order to stop the whole economic structure from collapsing because of government edict. I think it’s humane and not unreasonable. Or would you stand by and watch people lose everything?

  28. Diogenes says:

    How are Trump’s, and BJ’s “free” cash handouts any different to Krudd’s “stimulus” free $750 cheques in 2008-9?
    Today good, yesterday not good.

    A simple, polite explanation will be much appreciated.

    Gilas,
    my opinion, take it or leave it…
    Rudd pulled the trigger before it was needed, and as it turns out they were never needed.
    Today, totally different story, govt orders xyz to close, xyz sacks staff, so it is only fair govt shoulers the cost

  29. John A says:

    Spurgeon Monkfish III #3366993, posted on March 21, 2020 at 10:47 am

    the government does not create wealth

    It can only destroy it.

    It only destroys it.

    FTFY

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