Newspaper article The Christian Science Monitor

(False) Perils of Budget-Cutting

Newspaper article The Christian Science Monitor

(False) Perils of Budget-Cutting

Article excerpt

THE most common argument against federal budget cuts is a humanitarian one. Reductions in welfare-state programs, we are told, will yield terrible social consequences.

A new argument against budget cuts has emerged of late. It claims that budget cuts of any significance threaten to drag the economy into a recession or worse. These dire predictions, however, are based on an economic paradigm that has been discredited for well over 20 years.

From the mid-1930s until the early 1970s, disciples of the British economist John Maynard Keynes claimed to have solved the mystery of the business cycle. If the economy slows down and unemployment increases, the government must inject spending into the economy by increasing its expenditures or lowering taxes.

Conversely, if the economy begins to overheat, and prices begin rising, the government must remove spending from the economy via lower budgets or higher taxes. While oversimplified, this explanation is basically faithful to the Keynesian model.

The theory was severely tested during 1973-74, a period of inflationary recession or "stagflation." Prices and unemployment were rising. What was the Keynesian planner to do? He obviously could not simultaneously increase and decrease spending.

It can hardly have been a coincidence that in 1974, as the Keynesian model lay devastated, the Nobel Prize in Economics was awarded to F. A. Hayek, a free-market economist of the so-called Austrian school. Economists, desperate for an alternative explanation of business cycles, turned to Hayek.

Stated simply, Hayek's theory is as follows. Suppose the Federal Reserve increases the money supply through credit markets. One result is a lower interest rate. Investment projects that would not have been profitable at a higher rate suddenly become feasible, and businesspeople proceed to engage in a "boom. …

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