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• Government-induced Boom & Bust
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• Externalities & Government Intervention

Government-Induced Boom & Bust

Richard E. Wagner

• Auburn University

“Boom and Bust: The Political Economy of Economic Disorder.” The Journal of Libertarian Studies, Vol. 4, No. 1 (Winter 1980):1–37.

Keynesian economics maintains that governmental macro-economic management is required for prosperity. It assumes that unemployment in market economies is due to insufficient levels of total spending and that appropriate public policies can and will both eliminate the unemployment, and promote economic stability. Both of these assumptions obscure the actual relations between economic conditions and government policy.

Using a holistic approach to focus either on unemployment or price levels in the aggregate obscures the actual sources of prosperity and depression. In addition, the belief that public policy can and will work to promote stability ignores political realities. Politicians, desiring to stay in office, see government expenditure programs as ways of securing votes and they tend to promote programs financed by borrowing rather than taxation. Consequently, an incumbent government will attempt to use deficit finance to serve its political purposes.

If government borrows from private citizens to finance expenditures in excess of revenues it may raise market rates of interest and “crowd-out” borrowing for private investment purposes. This foments political opposition. It becomes possible to avoid this consequence through creating new money in the amount that government wishes to borrow. This is possible since government has effectively nationalized money and credit. Debt instruments are issued by the Treasury and monetized by the Federal Reserve. It then becomes possible for politicians “...to buy the support of a favored clientele, who benefit from the money expansion, without having to impose vote-losing taxes in the process stat or crowd-out private investment.”

Deficit-financed expenditure programs favored by politicians are intentionally discriminatory since they attempt to alter the distribution of incomes by changing the structure of relative market prices. The same is also true of tax reduction and money expansion programs. In addition, the actual results of such programs can only be understood by focussing on the changes in income distribution and in the structure of relative prices brought about by such political action.

In spending newly created fiat money, a politically favored group obtains control over resources, while at the same time altering the structure of relative prices. As the new money is diffused throughout the economy in additional transactions, one by-product is a rise in the absolute price level—which effectively reduces the control of resources by those more distant in the chain of transactions from the favored group. More importantly, the change in the structure of relative prices becomes a source of economic disorder.

Additional government-caused distortions insue. Deficit spending financed by monetizing treasury debt allows the amount of public and private borrowing to exceed the amount of private saving. The market interest rate is thus pushed below the rate of interest that would ordinarily clear financial markets—the “natural” interest rate. This artificially cheapens private real investment and encourages the expansion of more time- or capital-intensive production processes. Capital goods industries expand at the expense of consumer goods industries.

“With the production of consumer goods decreasing relative to that of producer goods, in conjunction with no greater desire of consumers to save, prices of consumer goods will start to rise in response to shortages of these goods. A self-reversal will set in motion: the capital goods boom will turn into a capital goods bust. The process of expansion that is set in motion by the money creation will reverse itself automatically, unless the inflation accelerates. Without this acceleration of inflation, much of this increased investment will turn out to be unprofitable. As these investments are scrapped or put to different uses, economic contraction will result. Excess capacity will arise as capital becomes unemployed. But labor will become unemployed as well. Both types of unemployment result from the previous inflation.”

Inflation and unemployment are thus directly related to a sequence of cause and effect, and “stagflation” is a direct consequence of government political activities. The cure is an end to the government policies that created the inflation. An inevitable result will be a recession until the economy's structure of production accurately reflects the underlying real data of wants, resources, and knowledge. Recession is an inherent part of the recovery process from politically induced economic instability.

The state monopoly over money is not intended to contribute to economic instability, rather the contrary. Nevertheless, the pursuit of political gain in a setting including that monopoly has that result. “By taking a variety of steps to remove money from the category of a nationalized industry, the ability of the ordinary vicissitudes of politics to promote economic disorder would be lessened.”