A colleague in a different field emails me:
On the side, what’s going on in your classes. I’m watching the economy, and all the money the government is throwing at it, and I’m wondering why? Is it going to help? Why are we a Capitalist society on the way up, and a Socialist economy on the way down? I know the answer is greed, but there has to be some other reasons?
From Wikipedia, here are the definitions of capitalism and socialism:
Socialism refers to a broad set of economic theories of social organization advocating state or collective ownership and administration of the means of production and distribution of goods, and an egalitarian society characterized by equal opportunities for all individuals and a fair or egalitarian distribution of wealth.
So, my friend asks, are we capitalist when our economy is doing well and socialists when it’s not? This is probably more of a political question but I will give my economist sense to what I think happens in the U.S. The U.S. economy is a mix of capitalism and socialism. There are many government jobs (I teach at a California Community College) and the government is the largest landowner in the U.S. When the economy is doing well, just about everyone is better off (There are debates on this fact and income inequality, a bit too much for this post now).
When the economy goes down, politicians start to feel the pressure from their respective voters. The pressure is to do something to make the economy better. Politicians do this through fiscal policy. As George Bush Sr. learned, it is not good to tell everyone the economy will fix itself later. People want action from their government, even more so than positive results. Right now, the economy and job market are declining at a very rapid pace. Politicians are forced in to crisis mode and are probably going to use over two trillion in government spending. So, the quick answer to my colleagues question is “Yes, politicians need to use more fiscal policies (possibly socialism) during economic declines”.
He also asks, why is the government throwing money at the problem and is it going to help our economy? The U.S. has had a debt problem for some time. Consumers and governments borrow and spend more than they should. This has led to an inflated Aggregate Demand (sum of all the U.S. demands). What is happening now (due to housing bubble, credit crunch, etc.) is the consumers have started to stop borrowing and buying. Consumers are sitting on their cash so there is a huge drop in AD.
Keynesian philosophy, in general and simple terms, states that the government should borrow and spend to increase the aggregate demand. If the government doesn’t do so, businesses will have to layoff more workers and we could end up in a depression. Fiscalspending should help but we really don’t know how much (this is where the academic debates are centered right now). We also don’t know if fiscal or monetary policies are better.
One major problem is the Fed can’t lower interest rates any more. Also, the Fed can’t force banks to lend and people to borrow. Fiscal policy is one of the last major options. There is a trad-off between borrowing now to save the economy vs. future debt. My personal take is that fiscal policy needs to be used along with monetary policies. If both policies are used properly, our downturn will be less painful. It’s a bit of a gamble but it needs to be done, otherwise, there could be some very upset voters.