Morningstar Advisor - August/September 2012 - (Page 57)

price-level target. But this is an idea way out of the mainstream right now. projects. At the end of the day, it does extremely little. So the typical Keynesian arguments that have been given for fiscal stimulus have been debunked many times. You may get a slight fire that looks good for a short period, but you’re going to have to worry about the resulting debt problems and tax problems down the road. Cochrane: All of Keynesian economics has a remarkably one-dimensional view of economic prosperity and decline. It’s all about spending. It’s too much spending or too little spending, or “aggregate demand.” That’s it. Stimulus Magnus: I’d like to discuss government policy responses to economic crises. Many people think it’s intuitive that the government should spend more when there is an economic downturn. In other words, the government should get a larger degree of power in deciding which goods and services should be produced and consumed. But do collective problems necessitate collective solutions? Could you give us the best arguments for and against increased spending during recessions? Uhlig: It’s complicated. It’s good to do certain things, not good to do other things. Let me first give you a pro argument. I walk around Chicago, and when I am under some of these bridges, I’m afraid they’re going to fall down. There are roads full of potholes. A good time to fix these things is, presumably, when wages are low in the construction industry, when there are lots of workers idle, and when you don’t have to compete against private business to do that construction. So you might as well fix them in a recession. The issue for fiscal stimulus is whether, above and beyond all that, if the government borrows a dollar and spends it, does that make the economy one and a half dollars better off? In Keynesian economics, it’s good for the government to borrow a dollar and spend it on something that ends up on the bottom of the ocean—totally useless spending is fine, because that raises GDP more than a dollar and a half. Literally, the key to prosperity is to pay people to dig ditches and then fill them up again. Is that proposition true? We’re saying it’s not. The answer why is quite simply because there’s a budget constraint. Those resources have to come from somewhere. It is not manna from heaven. If the government borrows a dollar from you and spends it, that’s a dollar you do not spend. And that just doesn’t work to raise GDP. Now, let me be a little bit of a heretic. In some sense, fiscal stimulus can work. Yes, you heard it here. How? Keynesian stimulus is about borrowing money and paying it back in the future. That’s what doesn’t work. Printing money can cause inflation, and sometimes a bout of inflation can fool people into producing a bit more for a while. But printing money, and dropping it from helicopters, as Friedman famously suggested, is fiscal policy, not monetary policy. The Fed always takes back government debt when it sends out money. Only the Treasury can, essentially, print money and give it to voters. And, back to the fiscal theory, money printing can only create inflation if you really persuade people that the government will not raise taxes in the future to soak up the money. If you want inflation, you want people to get rid of this money like a hot potato. I’m not saying creating inflation is good, but if you want to create inflation, you have to do it by fiscal stimulus. The tough part is convincing people that you’re absolutely going to be irresponsible and never pay it back. That’s just as tough as convincing people that you are Modern economies are like people with complex diseases. You find the cause of the problem and cure it. Keynesian economics is like the old humors, except there were four humors and there is only one Keynesian diagnosis and remedy. Diagnosis: inadequate “demand.” Remedy: fiscal stimulus. That’s not how economies are. We had a recession because we had a financial crisis. The bailouts I didn’t like so much, but a lot of things the Fed did to address the financial crisis affected the financial problems. Greece’s economy is going down the toilet. Is that really because its government isn’t spending enough? We know lots of other things that are wrong. Greece is full of structural problems. The whole economy has sand in the gears. Pouring on more gas doesn’t address those problems at all. But let’s talk about stimulus itself. Like Harald, I want to clarify what the question is. Of course, governments should run deficits in recessions. For the same reason that if you lose your job, you shouldn’t stop eating. You dip into your savings for a while and go look for another job. Governments are the same way. That means you’re running deficits in recessions. As Harald mentioned, recessions could also be great times to do positive value projects, because the construction workers come cheap and so forth. Another pro are automatic stabilizers. People want to be insured against business-cycle risk, but they have low-paying jobs and can’t go out and buy fancy financial contracts. So developing government institutions that insure them against business-cycle risk by having some form of unemployment insurance is sensible. Government spending automatically goes up via these automatic stabilizers during downturns, but it’s a good thing. It’s a bad thing, however, if you’re in a fiscal crisis and you try to spend yourself out of it. Fiscal stimulus in a recession, as we saw in 2009, also doesn’t work, because the lessons that we have learned over the past 40 years applied again. The spending comes too late, and it’s often devoted to the wrong MorningstarAdvisor.com 57 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2012

Morningstar Advisor - August/September 2012
Contents
Contributors
Letter From the Editor
How Much of the Behavior Gap Is Your Fault?
What’s Your View of the Muni-Bond Market?
A Balanced Life
How to Get to Know EMMA
A Strong, Robust Fund Business
Dividend Investing Abroad
Four Picks for the Present
Investment Briefs
Fund Expenses Through the Decades
Autos on Comeback Track
Lessons From the Muni-Bond Rebound
Municipal-Bond Landscape Shifts
Municipal Bonds 101
A Tale of Two Cities
Unraveling the Mysteries of Money
Small Companies Mean the World to Him
The Chinese Art Market and the Origin of Bubbles
The Myth of the Dumb Investor
Stocks That Can Stand the Heat
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The War on Savers

Morningstar Advisor - August/September 2012