Spending

I'm still not an economist, yet I continue to be amazed by what must be either the economic illiteracy or deliberate obfuscation of the McCain/Palin campaign. The all-purpose answer to the question of how we got into, and how we should get out of, the current crisis, is government spending: The government spent too much in the past and should spend less in the future. Sen. McCain has said something like this over and over again, including in Friday's debate, and Gov. Palin, to the extent that she said anything that could be said to have propositional content, seemed to reaffirm the point in her Katie Couric interview.

Let's begin with the low-hanging fruit. If someone were committed to the proposition that government spending is bad for the economy, wouldn't he or she be strenuously opposed to the bailout? Indeed, wouldn't he or she be opposed to all of the proposed alternatives to the bailout that involve large expenditures of government funds? I suppose one could support the bailout---or at least not oppose it---if one thought the government would end up making a profit, but that seems unlikely here, and in any event, one hears absolutely nothing from McCain or Palin about why, if government (non-military) spending is generally bad, this time it's even a necessary evil.

Now the slightly higher fruit: Within the last couple of weeks, McCain has sometimes suggested that the underlying cause of the current crisis was "greed" on Wall Street, notwithstanding the fact that as a free marketeer, he was supposed to believe that through the magic of the market, private greed leads to public good. Perhaps because McCain is not convincing attacking greed, he has also stuck with his other explanation: government spending has gotten out of control. During Friday's debate, he cited government spending over and over again as the cause of our problems, including, specifically, the current financial crisis. To wit: "And the reason, one of the major reasons why we're in the difficulties we are in today is because spending got out of control."

Huh? There are plenty of reasons why one might think that wasteful government spending is a bad idea, but surely it was either irrelevant to, or actually worked against, the causes of the financial crisis. The housing bubble facilitated the sub-prime mortgage crisis because, with home prices rising, lenders didn't worry about borrowers' ability to repay: If the borrower defaulted, no biggie; the house is worth more anyway; and borrowers falling behind in their payments could simply flip the houses for a profit. What, if anything, was the effect of federal deficit spending on the housing bubble? Probably to make it a little less bubbly than it might have been. When the government spends more money than it collects in taxes, it must borrow money. That government demand for credit in turn raises the cost of credit, i.e., drives interest rates up, which makes home purchasing somewhat less attractive. So, without excessive government spending, we probably would have had even lower interest rates, and an even larger bubble.

There is a possible counter-story here: Low interest rates were the product of a deliberate Fed policy of economic stimulus that wouldn't have been necessary but for the drag that government spending had on the economy. There's no really good evidence that the Bush deficits dragged the economy in this way; a Keynesian would say just the opposite. But to the extent that one buys this counter-story, then the blame for keeping interest rates falls on the architect of the Fed policy, Alan Greenspan. And McCain, while listening most to Phil Gramm on economic matters, has frequently cited Greenspan as his great sage. So the counter-story is an even bigger mess for McCain.

To be clear, I'm not saying that the Bush deficits have been good for the economy. What I am saying is that tracing their effects requires at least some rudimentary understanding of supply and demand. If McCain has such an understanding, he has not explained how his single-minded focus on government spending as the root of all evil fits in with it.

Posted by Mike Dorf