Remember when trendy thinkers insisted that old-fashioned concepts about supply, demand, prices, and deficits had been swept away? They told us the economy could largely be molded as policymakers wished, promising a new world of prosperity directed from above. Then the pandemic came along, providing a test-case for high spending, money-supply expansion, and statist interventions. Ouch. Old-fashioned economic concepts turned out to be pretty current, after all.
"Some years induce us to question established theory, and to see new and unusual possibilities for the future," writes George Mason University professor of economics Tyler Cowen. "Not 2022. This is the year that orthodoxy took its revenge."
Cowen goes through a thorough round-up of the year, but signs were there from the beginning for anybody paying attention. In February of 2022, The New York Times profiled Modern Monetary Theory proponent Stephanie Kelton. As reporter Jeanna Smialek noted, MMT "posits that if a government controls its own currency and needs money … it can just print it, as long as its economy has the ability to churn out the needed goods and services." The piece was obviously planned as a celebration of Kelton. But after trillions of dollars in "stimulus" spending under two presidents, developments required a few notes of skepticism.
"Inflation had rocketed up to 7 percent. The government's debt pile has exploded to $30 trillion, up from about $10 trillion at the start of the 2008 downturn and $5 trillion in the mid-1990s," noted Smialek. "Some economists blame big spending in the pandemic for today's rapid price increases."
Inflation went higher from there, and not just in the United States. Countries that flooded the world with money found, as often predicted, that money bought less.
"About $16.9 trillion in fiscal measures was announced globally to fight the pandemic, with relatively larger support in advanced economies," the International Monetary Fund's Ruchir Agarwal and Miles Kimball commented in an analysis of high inflation. "A warning that the large fiscal stimulus, combined with easy monetary conditions, would lead to high and persistent inflation came from a group known as 'Team Persistent' … the evidence had shifted in favor of Team Persistent across several countries."
"Not long ago, economists insisted that demand shortfalls were perpetual and that stimulus was almost never excessive," adds Cowen. "That extreme version of the Keynesian view has been laid to rest, while a version of Milton Friedman's monetarism is ascendant once again."
Agarwal and Kimball also pointed to several other factors contributing to rising prices, including Russia's invasion of Ukraine, shifts in demand among customers sent home by lockdowns and social distancing, and labor disruptions. They noted that "lockdowns and mobility restrictions led to severe disruptions in various supply chains, causing short-term supply shortages."
This wasn't a new insight after months of backed-up shipping, shuttered factories, and empty shelves.
"Market economies tend to be pretty good at getting food on the supermarket shelves and fuel in petrol stations, if left to themselves," British economist Philip Pilkington had pointed out in 2021. "That last part is key: if left to themselves. Heavy-handed interference in market economies tends to produce the same pathologies we see in socialist economies, including shortages and inflation. That has been the unintended consequence of lockdown."
Fortunately, adds George Mason's Cowen, "a further lesson is that supply chains do untangle themselves. Photos of cargo ships waiting to be unloaded were once a regular feature of my news feed. The availability of foreign goods and services was spotty, and their prices could be high. Throughout 2022, most of those queues and logjams dissolved, as the market was allowed to operate. Once again, a very traditional approach to economics was vindicated."
If letting loose the magic of the market largely repaired the damage done by government officials interfering with supply chains, traditional market responses also helped to offset some damage done by another statist intervention. Pre-pandemic, left-wing activists pushed to hike the minimum wage, raising the price floor for labor. It had predictable results for employers and for entry-level and unskilled workers priced out of the market.
"New York City business owners are eliminating jobs, cutting hours, and raising prices in the wake of a $15 minimum wage hike implemented at the end of last year," Reason's Billy Binion wrote in 2019.
But the social disruptions of the last few years played havoc with work habits. "Labor supply participation remains below pre-pandemic levels in several countries," in the words of the IMF's Agarwal and Kimball. That means labor prices rose above the floor set by many minimum-wage laws.
"Wages have surged, particularly for low-wage workers, since the pandemic for several reasons, including widespread labor shortages," Austen Hufford reported last week for The Wall Street Journal. "Through September, the lowest 10 percent of workers by income in each state earned hourly wages that were on average one-third higher than their state's minimum wages."
Undoubtedly, inflation plays a role, too, since the money with which workers are paid loses value. Some states index minimum wages to inflation, but most don't, making minimums less relevant as the dollar amounts in which they're denominated buy less. Unfortunately, since high inflation continues, this means a race between rising wages and falling purchasing power, with too many people left poorer.
"Consumer prices rose 7.1 percent in November from a year before," adds Hufford. "After adjusting for inflation, average hourly earnings declined 1.9 percent over the same period for all private employees."
The market works very well, and in expected ways, when allowed to function. But it can't immediately undo all of the distortions created by extensive intervention in the economy.
"Centrally planning a fundamentally decentralized system isn't possible for very long," Tyler Cowen observes of the economic impact of China's failed COVID Zero policy.
That's an insight that could easily be applied to all the harm done in recent years by economic interventions. Allowed to function, free markets can, eventually, heal the damage done by government officials trying to "improve" on the voluntary interactions of millions of buyers, sellers, employers, and workers. But we'd all be better off if politicians just spared us the economic experiments.
The post 2022 Proved That Governments Can't Improve on Good Economic Principles appeared first on Reason.com.
