Dr. Sherry Jarrell

The Insanity of Government Spending

Until Congress and President Obama can find the discipline to cut (non-defense) spending, all spending increases must stop. Otherwise, obviously, we will be stuck with them forever -- this year's additional spending will become the spending Congress refuses to cut NEXT year.  

 

S&P Ratings - They either mean something or they don't

You cannot have it both ways. Either the bond credit ratings mean something, or they don't.  Public officials cannot point to the AAA ratings as evidence of good policy, then lambast them as "inaccurate" and "flawed" when they drop to AA+....or below.  

It is a fact that the ratings agency does not originate information; it simply gathers and interprets data that are publicly available to all of us.   The rating itself, however, is unique in that it summarizes a particular agency's forecast of how likely the US government is to repay its debt and sustain its borrowing needs.  

Don't get me wrong -- there is a LOT of information out there about the risk-adjusted rate of return on US debt to be digested.  But we don't have to re-examine it from the ground up -- we need only look at the marginal changes, the most recent developments, the direction of change, to update our expectations, and -- in my view -- to understand easily why S&P downgraded the debt.  

I think most of us realize that all government spending is financed by the private economy but I'm not as sure that everyone realizes that the return on government debt is also enabled by the productivity of the private economy.   The more productive the private economy, the higher rate of real return we can afford to pay on U.S. debt, and the more willing others are to buy our debt.  Being able to generate a return on debt is a good thing -- it's a sign of a healthy economy.   

Then there is the other side of the equation: the required return on debt from the point of view of the lender. The lender assesses the risk (or likelihood or uncertainty) that they will get their money back (and that the "money" is worth the same per dollar....so we are ignoring inflation just to simplify things).   The less certain they are, the higher the return they are going to demand before they buy the debt.  This required rate of return is a cost to the economy -- a higher cost eats away at profits, and makes the economy less productive, less able to reinvest, employ capital and labor, and grow.  

In the simplest terms, government spending is supported first by taxes and then, when those run out, by borrowing.  The debt ceiling debate made it clear that Washington was unwilling or unable to reduce or curtail government spending, which was on its way to starving the private economy of the sufficient earnings, liquidity and financing to continue to be productive.  The wealth creation capacity of the private economy is vast and impressive and has somehow miraculously employed labor and capital and supported AAA rating returns on government debt for a very long time, but it's not limitless.  

No, the ratings do not originate information. They simply publicly confirmed what many of us who understand and respect what private enterprise does day in and day out saw coming:  the current level of government spending is unsustainable. The private economy cannot take much more of the oppression and costs imposed by government policy, taxes, fees, regulations and -- perhaps the most troubling and insidous of all -- the public denigration and disparagement of the private economy, Wall Street and capitalism by our President.

 

It will be very interesting to see if this was a surprise to the markets.  

The Sad State of Macroeconomics Theory

I have to get this off my chest.  Macroeconomics is not economics at all.  What little sense it makes can be traced directly back to the bits and pieces of microeconomic that is uses along the way.  

Macroeconomics is basically nothing more than glorified national income accounting with a lot of politics thrown in.  And accounting is the antithesis of anything finance and economcis.

I believe that Keynes was looking for a theory that would support his idea for how to fix a depressed economy.  And his work is what justifies most of the government's fiscal policy to this day.  

The problem is that his view of the macroeconomy is incomplete, illogical and, most troubling, it is static.  

Reader's Question: Is Bernanke the problem?

Reader Randy Tanner asks "Is Bernanke the problem?"  in response to a recent article by Vasko Kohlmayer titled Why Isn't Peter Schiff Head of the Fed? In that article, Kohlmayer makes the case that over the period 2002-2007, while Ben Bernanke was saying that the economy was strong, Peter Schiff was warning us about the coming housing bust, rising unemployment, and falling dollar.  

The short answer is no, Bernanke is not the problem, not in the way Kohlmayer implies, at least.  The Fed did not cause the financial crisis.  I personally do not like everything about the way the Fed responded to the crisis, in particular their purchase of toxic assets, but they did not cause the crisis.  

And, no, Schiff should not be running the Fed, even if I believed that successfully predicted falling housing prices, rising unemployment, and a weak dollar. Which I don't.  But again, not in the way you might think.

Being a good economist does not require one to predict the state of the economy during a certain window of time.  In fact, the very best forecasters know to not even try to predict economic activity beyond the next quarter.   

No, what good economists understand is cause and effect, and most of that occurs at the level of the firm, the consumer, or the transaction.  Extrapolating that to the level of the economy involves so many countervailing factors that "predicting" what will happen at the macroeconomic level is not really meaningful.  In other words, you can find someone out there at any point in time making predictions about macroeconomic outcomes who will end up being "right."  Eventually.  On some level.  And this does not help us to make better policy, to allow the economy to be as healthy and productive as possible.

Let me give you a specific example to help make my point.  And I agree at the outset that Randy's point is a difficult one to argue against, and that my point is fairly subtle.   What I believe was perfectly predictable was the impact of the political decisions that mandated easier and cheaper access to home ownership, and charged Fannie Mae and Freddie Mac with implementing those policies.  When the government inserts itself between suppliers and demanders, as it did with these policies, it distorts the price signal and gets either too much or too little of that economic activity.  

So what happened here?  Because of the mandates, banks made loans to individuals that they would not have otherwise, largely because Fannie Mae and Freddie Mac were standing in the ready to buy those mortgages from the banks and get them off the banks' books.  So the banks did not have to bear the risk of those homeowners defaulting on the loan.  Therefore, those mortgages were underpriced.  And if the interest rates had been higher, where they should have been, less creditworthy individuals (which include high income individuals overextending themselves with a second mortgage as well as low-income individuals overextending themselves with too much house) would have not have applied for the loan in the first place.  

If you lower the price of an activity, the demand for that activity rises.  So the mandates led to a situation where a larger-than-sustainable fraction of existing mortgages were high risk, were susceptible to foreclosure should the economy take a turn for the worse. THAT is what is predictable, not that the economy in fact took a turn for the worse.   

Left to their own devices and profit-incentives, banks are perfectly able to price mortgages and absorb the risk that a fraction of those mortgages will go belly up.  And the private economy is perfectly well equipped to pool those mortgages, combine the funds, and issue and fairly price various mortgage-backed securities.  

The problem centers on the fact that a politically motived player in the form of Fannie Mae and Freddie Mac used our tax dollars to pursue a social agenda instead of a dollar of profits.  Mr. Schiff seems to overlook this fact as a primary contributor to the financial crisis, and Mr. Bernanke, though I suspect is fully aware of the issues surrounding Fannie and Freddie, is not responsible for what Fannie Mae and Freddie Mac do, and must enact predictable monetary policy regardless of their actions.  

Again, I do have issues with the Fed's actions over the last few years, and I do worry about inflation and the loss of autonomy of the Fed to the brutish attitude of the Treasury, but those are separate issues in my mind from the supposed ability of Mr. Schiff to predict the housing crash and the financial crisis of the recent past.  

It is possible to flip ten heads in a row; unlikely, but possible.  And the 10th toss does not predict the 11th.  They are independent events.   Predicting the 11th toss based on the preceding 10 makes as much sense as predicting that housing prices will fall because they are now high.  Neither prediction is based on economics.   But when you use tax revenues to subsidize high-risk mortgages, economics correctly "predicts" that more foreclosures and financial distress will occur than would have otherwise. That's a prediction you can count on.

 

 

Fannie Mae and Freddie Mac: Scary

Fannie Mae and Freddie Mac are at the very core of the most recent financial crisis. Without them, the crisis would not have occurred.  Fannie Mae and Freddie Mac get between lenders and borrowers and distort the pricing of their transactions.   Fannie Mae and Freddie Mac have, as their mandate, social engineering, not arms-length business negotiations conducted for mutual benefit.  They have no business worming their way around our economy.  

Fannie Mae and Freddie Mac continue to operate because they make politicians better off, not business people or consumers. Someone is getting their pockets lined.  I believe that when the real operations of Fannie Mae and Freddie Mac see the light of day, that you will be stunned by the sheer magnitude of the fraud, corruption, and destruction of wealth.

You heard it here first.  

For fabulous reporting on all things housing, including Fannie and Freddie, I follow Nick Timiraos on twitter (http://twitter.com/nicktimiraos).

We have it Exactly Backwards!

The next time you hear about the deficit, the level of government spending, or a new bailout program, please consider the following.   We have it backwards:  government spending should never justify collecting taxes.  Instead, collecting taxes should first be fully justified by the specific government spending.   If we cannot justify the government spending as absolutely necessary for the public good, then the dollar of taxes should never be collected.

Instead, today, taxes are routinely collected and THEN the politicians fight over how the taxes are going to be spent. In fact, government spends future tax revenues!

We have it backwards. The press has it backwards.  The pundits have it backwards. Congress has it backwards. The White House has it backwards.    The only debate out there seems to be about WHAT we spend the tax revenues on, instead of whether the tax revenues should be collected in the first place.  

I think if we put government spending to such a test, we would decide against most of it, and our taxes would fall to a level that supported a vibrant economy with low unemployment and stable prices. 

 

Where did U.S. Incomes Go?

I've taken the liberty of reprinting in its entirety a recent piece by Karl Denninger of Market Ticker on the state of U.S. incomes.  This piece helps underscore the inescapable reality that private industry drives our economy.

"It appears that the Federal Tit Pump is running out of power...

Personal income increased $1.2 billion, or less than 0.1 percent, and disposable personal income (DPI) increased $1.6 billion, or less than 0.1 percent, in February, according to the Bureau of Economic Analysis.  Personal consumption expenditures (PCE) increased $34.7 billion, or 0.3 percent.

Oh boy, now the $1.3 trillion in additional deficit spending is no longer contributing to personal income!  That's not so positive - indeed, it's not positive at all.

Private wage and salary disbursements increased $2.0 billion in February, compared with an increase of $16.6 billion in January.  Goods-producing industries' payrolls decreased $3.5 billion, in contrast to an increase of $5.2 billion; manufacturing payrolls decreased $1.4 billion, in contrast to an increase of $5.0 billion.  Services-producing industries' payrolls increased $5.5 billion, compared with an increase of $11.4 billion.

Goods down.... uh, where's our so-called economic recovery? 

Proprietors' income decreased $6.1 billion in February, the same decrease as in January. Farm proprietors' income decreased $7.1 billion, the same decrease as in January.  Nonfarm proprietors' income increased $1.0 billion, the same increase as in January.

Very little change in proprietor's income ex farming, but farmer income is down significantly.

Rental income of persons increased $2.2 billion in February, compared with an increase of $1.9 billion in January.  Personal income receipts on assets (personal interest income plus personal dividend income) decreased $16.5 billion, the same decrease as in January.

Rents up a bit, but dividends are down huge, continuing a trend.  This is not positive at all, and implies that assets are being sold to continue lifestyle choices.  This leads to a question that has begun to gnaw at me: Have we begun to cross into where boomers start pulling funds out of asset classes to live on?

Personal current transfer receipts increased $16.6 billion in February, compared with an increase of $29.8 billion in January.  The January change reflected the Making Work Pay Credit provision of the American Recovery and Reinvestment Act of 2009, which boosted January receipts by $19.8 billion. The Act provides for a refundable tax credit of up to $400 for working individuals and up to $800 for married taxpayers.  When an individual’s tax credit exceeds the taxes owed, the refundable tax credit payment is classified as “other” government social benefits to persons.

Government to the rescue!  $45 billion worth in the last two months, to be specific.  That's a direct $270 billion in handouts, or 2% of GDP - and that's only the direct handouts!  So subtract that off GDP and..... (oh, and don't forget the rest of the $1.3 trillion too.)

Nothing to see here folks, as in "no evidence of sustainability in the recovery."  We have a government that continues to "prime the pump" but there's no water at the bottom of the well to generate self-sustaining economic growth. 

by Karl Denninger

Should you Invest in U.S. bonds? Part 3

This is part 3 of a multipart series on the factors that drive U.S. and foreign bond prices and yields.

The yield on a bond is made up of several components. Some think of the return on a bond as the sum of the risk-free rate of interest (how impatient we are to get our money back, or how much we need to be compensated to delay consumption) and a risk premium (the additional return we require to compensate us for the risk of default, the risk the bond will be called, the risk of inflation reducing the purchase power of the repaid dollars, and many other sources of risk as outlined in the most recent article in this series).

Another useful way of thinking of the return on a bond is as the sum of the real rate of interest and the expected rate of inflation.  But what is the real rate of interest?  We never actually observe that rate, unless of course the inflation rate is zero and then the real rate is just the nominal rate set in the market.

It is useful, however, to think about what drives the ability of a company to generate a real rate of return to lenders, for this is essence of capitalism and risk-taking and creating economic value and growth.

Bond traders

A firm’s asset cash flows support the real returns to its lenders – all kinds of lenders (debt, equity, hybrid, and derivative security holders). A firm will want to borrow more, and is willing to pay a higher interest rate for those funds, the more profitable are the projects they want to undertake, or the greater the number of profitable projects. Profitability, in turn, is determined by the relationship between demand and supply:  how much does society value a good or service, and how many resources does the business use in producing the good or service.  As the marginal productivity or efficiency of a business goes up, it can afford to profitably fund more projects.  So the core driver of the real return on bonds is the strength of the underlying economic activity of the private economy.

Or, when viewed from the investor’s side, note that an investor will purchase a bond, or lend money to a company, if they expect to earn a return sufficient to compensate them, first, for delaying consumption and, second, for bearing the various sources of risk or uncertainty associated with the bond’s cash flows or return.

Bond’s in a weak or faltering economy will generate a lower return to lenders than bonds in a strong economy, absent inflation or any other material changes in the purchasing power of the currency.  Weak demand for goods and services means weak demand for financial capital which means low rates of return on financial capital.

The policies of the government can increase the borrowing costs of private industry.  Fiscal policy that increases taxes reduces the profitability of projects and undermines the ability of companies to pay coupons and repay principal.  Monetary policy that increases the money supply may lead to inflation, which also increases the cost of borrowing and reduces economic activity.

Lastly, and of the greatest concern of late, is the level of borrowing by the U.S. government.   Debt levels are at record highs, with no relief in sight. The AAA rating of U.S. debt is reportedly in jeopardy (Chicago Tribune editorial).  Both existing and new lenders worry about the ability of the U.S. government to repay. Yes, the can simply roll over existing debt by raising taxes or creating money to retire old debt and replace it with new, but the interest rate required by new lenders goes up as the ability of the private economy to sustain tax revenues falls and the risk of inflation rises (Moody's explains U.S. bond rating).

Both factors are in play now: an anemic economy with little hope that this administration will undertake policies that support business, and a ballooning money supply and weak dollar that undermine the purchasing power of the returns to lenders.  The returns to U.S. debt may still be healthy relative to those one can earn in other countries, but the spread is shrinking. The private economy remains fundamentally strong, thanks to the work ethic of the American people and the profit motive of the capitalistic system, but the policies of the U.S. government are straining those resources.

Latest US Growth Rate

The U.S. GDP grew at an annual rate of 5.9% in the last quarter of 2009 which may look good at first glance, but when we dig a little deeper, we find some concerns about the implications for sustainable growth.  A large fraction of this reported growth came from businesses selling off accumulated inventories, which has more to say about past production than current. Exports were also a significant source of fourth quarter growth, driven in large part by a weak dollar.  Of course, a weak dollar is a very mixed blessing for the economy, and is hardly a sign of a strong or recovering economy.
 

Real residential fixed investment increased 5.0 percent, helped along by the extension of the home purchase tax credits from the federal government. 

Real nonresidential fixed investment increased 6.5 percent. This figure nets out nonresidential structures, which decreased at a troubling rate of 13.9 percent, and equipment and software, which increased 18.2 percent. Investment in equipment and software consists of capital account purchases of new machinery, equipment, furniture, vehicles, and computer software; dealers’ margins on sales of used equipment; and net purchases of used equipment from government agencies, persons, and the rest of the world. Own-account production of computer software is also included, which is production performed by a businesses or government for its own use.  

Again, the underlying figures show that those variables most associated with building a sustainable productive capital base for the economy – nonresidential fixed investment –are declining at an alarming rate. This, combined with a 9.7% unemployment rate and the specter of rising debt levels, energy prices, and taxes, paints a picture of a slow to non-existent recovery to a robust economy any time in the next year. 

http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

Does Fed Rate Influence Consumer/Business Interest Rate?

Does the Fed Funds Rate, the rate charged by the Federal Reserve to make short-term loans to banks, directly influence the interest rate consumers and businesses pay on credit cards, mortgages, and consumer and business loans?  If you took the word of the average business news commentator, you would think not.  But the answer, of course, is yes.   

One way to view the market rate of interest, although certainly not the only correct or useful way, is to think of it as a base rate that represents the risk-free rate, a rate that compensates the population for its impatience to consume the goods it would have consumed had it not lent the funds out in the first place. This risk-free rate is also influenced by the efficiency and functioning of the capital markets that bring borrowers and lenders together.

A risk premium is then added to this base rate of risk-free interest, one that varies depending on the degree of uncertainty of the lender getting repaid.  The risk of default, the risk of prepayment, the risk of political uprising, exchange rate risk, and many other sources of uncertainty -- including the risk of inflation -- raise the level of the risk premium commanded by lenders in the market.  As an example, over the last 100 years or so, the average annual risk-free rate in the U.S. has been about 4%, and the average annual risk premium for equity securities has been about 8%, bringing the average annual observed interest rate or rate of return to about 12% on these securities.

So what happens to the interest rate charged to consumers and businesses when the Fed raises the fed funds rate?  Basically, the level of the risk-free rate in the economy rises and, as debt contracts expire or new lending takes place, this higher base rate gets factored into the market rate of interest charged.  

Overall, the demand for loanable funds falls, the aggregate demand curve for the economy falls, and equilibrium output and employment fall, RELATIVE to where they would have been without the rate increase.  The bright side is that a reduction in the money supply that accompanies an increase in the fed funds rate is absolutely essential to curtailing inflation, which drives the risk premium, and represents a much greater cost to the economy.

Oh, the Irony: The Market Speaks, and Obama Has to Listen!

In a recent article, Moody’s announced that because of the U.S. federal government’s excessive spending and historic debt levels, it might have to reduce the Aaa rating of U.S bonds (http://thecitysquare.blogspot.com/2010/02/us-aaa-bond-rating-threatened-by-obama.html and http://risingpowers.foreignpolicyblogs.com/category/multipolarity/)
 

What this means in practical terms is that the cost of borrowing by the U.S. government will rise, which will increase spending via more borrowing or higher taxes or more money creation to pay for the higher interest costs.  Sound like a vicious cycle to you?  

Has anyone noticed the absolute irony of the world capital market having a seat at the table that assesses the viability of Obama’s policies? Obama has spent the last year denigrating free markets, and has laid the blame for the credit crisis squarely at the feet of those "greedy capitalists." Now he has to deal with a rating agency, which plays a pivotal role in the functioning of those very capital markets, evaluating the creditworthiness of the policies of the White House and its Budget Director, Peter Orszag.  

How wonderfully ironic! 

 

Parenting the Government: More Q and A

Patrice Ayme continues:

Hi Sherry:
I made several points. Indeed by “public utility” I allude to public as in res-publica.
Funny you said that a “national interstate roadway system” should be paid by taxes. As I said, in France, it’s private, and paid by the proverbial ‘end user’. So much for France being socialist and USA private profitist. Please forgive the neologism.

I gave the example of waterworks. Private French companies lead worldwide in that domain. That means French (local) government use taxes to pay them. But recently some government realized they could get more services by doing the work themselves. So, in this case, they start as before: taxes. But then, instead of paying some giant private French water company, they pay municipal workers and engineers to do the work. Cost less (less taxes), better service.

Call that an anti-Jarrell universe. A mystery, like anti-matter. How could that happen? Very simple: think about it: the municipal government does not have shareholders (just stakeholders) and does not have to pay dividends, and does not have to increase the value of the shares by showing profits. It actually has no profits to make. So the end user (the denizen of said city under his city government) saves money (i.e., taxes), improves services.

This example, of course carries to health care. France has also a competition of public and private health care systems, large pharmaceutical companies, etc… And has done more face grafts (in public hospitals) than the rest of the world combined… and the first successful gene therapies (also in public hospital), etc. Was is it not to like? If profitist ideologues in the USA were not so greedy, they would see the necessity of having a strong public sector, be it only to keep the private sector honest.

By the way, French politicians are regularly condemned for corruption, and it’s not because they are richer than their colleagues in the USA, by a long shot…

My reply:

Ah Patrice….here we go again! For one, I did not say that government “should” pay for a national highway system, I said that we do pay for a national highway system. A positive statement, not a normative one.

I guarantee you that in any universe – not just the Jarrell one – the true cost of anything paid for by the government with tax dollars is understated by several orders of magnitude. And, possibly, overstates benefits. It is simply factually incorrect to say that the cost (the true economic cost as measured by the use of resources) of providing the service is less when provided by the government. The one-period ACCOUNTING cost put on paper by some government office, as reported to the press, and swallowed whole as fact by readers, may be less. But it is literally, factually impossible for the true costs to be reduced by inserting a redistributive middleman between consumers and business.

You also fail to understand the relationship between stock prices and economic value. You should step back, slow down, and consider the following. Let’s get dollars and stock prices and dividends and profits out of the equation entirely and just think about the amount of goods and services provided versus the amount of resources used up in the production of those services. Measure it however you want — quality of life, health of the citizenry, happiness, kumquats. Now ask yourself which is the most “efficient”method of providing final goods and services, where efficiency is measured, as it should be, as the number of units of output of the good and service provided per unit of resources used up in production process. The “dividends” and “capital gains” in this analogy are the EXTRA value created from a capitalist system; take one input, create 2.5 outputs, added value is 1.5. The government as provider creates zero extra value, if we are lucky, and negative value, if we are realists: take that same input, chew up half its value in bureaucracy, buying votes, and redistributing the consumption decisions of a free people toward something they would not choose to purchase in the first place (otherwise, why the government program in the first place?), and produce 0.5 total outputs, a loss of 0.5. The social loss from moving from capitalism to collective command and control is 2: from plus 1.5 to negative 0.5.

Yes I am including spending on defense and clean air and roads. When we spend on collective goods, we use resources less efficiently. This spending infringes on our economic freedom, but some goods and services are necessary to protect and preserve the system that enables that economic freedom.

You and I can and most certainly do disagree on where to draw the line on what goods and services the government should provide over the objections of a free people, but we cannot disagree on facts. Your claim that government provision of goods and services is less costly than private industry is factually incorrect.

An Overview of Macroeconomics

    Macroeconomics is the study of aggregate supply and demand, and looks both internally 

to the workings of the economy and externally to how a domestic economy interacts with others 

worldwide.  Macro builds on the principles of microeconomics, which is the study of prices and 

quantities of individual goods and the markets where these goods are produced and sold. In macro, 

"price" refers to some index of the prices of domestic goods and services, and "quantity" refers 

to some measure of the value of domestic production or "output." One common measure of output is 

gross domestic product ("a measure of the productive activity of a country computed on the basis 

of the ownership of the factors of production"). A country's standard of living is usually directly 

correlated with its real output, or the value of total output corrected for inflation. 

    Unlike microeconomics, macroeconomics started with the idea that prices and markets do not 

continuously resolve all of the coordination requirements of a modern economy. Such "failures of 

coordination" (Keynes) seem likely when one views the economy as the collective sum of thousands of 

microeconomic markets. For example, although most economies around the world have experienced generally 

positive trends in their gross domestic product, short run positive and negative deviations (recessions 

and, in more dramatic examples of the failure of coordination, depressions) around the trend line, or 

"business cycles," are common. 

    Inflation is the rate of change of the average level of prices, where the price level is 

usually measured as a price index.  Inflation rates are typically quoted in annualized percentages.  

In normal times, the inflation rate is procyclical: it rises in periods of high growth and declines 

in periods of slow growth.  Unemployment, by contrast, is usually countercyclical. The U.S. inflation 

rate was as likely to be negative as it was positive before World War II; since then, price levels 

have risen fairly consistently.

     Financial markets play a key role in macroeconomics.  It is here that resources are collected 

from savers and lent to producers for investment in the real economy.  The real economy stands in 

contrast to the nominal (or financial or monetary) economy.  The real economy is concerned with the 

production and consumption of goods and services; the nominal economy deals with the trade in assets, 

such as monetary and financial instruments.  Physical investment, which is the acquisition of the 

physical means of production by firms, provides one channel by which financial markets affect the real 

economy.

    Two fundamental approaches to macroeconomic policy have arisen, both of which are concerned 

with how to manage the inevitable failures of coordination between the micro units in the economy. 

Demand side: the use of government demand to smooth out fluctuations in the economy, mainly to avoid 

protracted recessions. Supply side: improving the efficient utilization of labor and capital resources

to enhance the productive capacity of an economy.

    One can also usefully separate the approaches to macroeconomic policy into laissez-faire and 

interventionism.  Keynesians are frequently characterized by the view that markets are imperfect and 

that government holds an information advantage and should engage in active policy interventions in the 

economic activity of the markets.  Monetarists see politics and bureaucracies as barriers to government 

attempts to deal successfully with market failures, which they see as just one step toward a self-correcting 

market mechanism.   Monetarists tend to reject activist policies because of uncertainties, policy lags, and 

government incompetence.

    Which of these two approaches are currently in favor depends on the state of our knowledge of the 

causes and effects in macroeconomics and also, perhaps largely, on politics.  The close link between the 

state of the economy and politics is summed up by the "misery index," which has no scientific basis but so 

closely predicts the political fortunes of incumbent governments that most believe it does contain substantive 

information about the electorates’ views on how well the government has managed the economy.  The misery index 

is the sum of the inflation rate and the rate of unemployment, two measures of national performance that are 

easily understood and monitored by the voting public.  Incumbents tend to be thrown out when the misery index 

is rising.   Economies are alike in that they hold their governments responsible for the health of the economy. 

Where they differ is in how hands-on the government should be (a "normative," as opposed to a "positive," 

statement) in making things better!