What government can–and should–do is influence the environment in which this hum of activity takes place. The key variables: taxation, monetary policy, government spending and regulation. In almost all instances the best prescription for economic health is “less is more.”
Catastrophic mistakes by governments can poison the marketplace, as happened spectacularly during the 1930s and, to a lesser extent, the 1970s.
We are living through a similar period now. The Federal Reserve’s and the Treasury Department’s blunders in weakening the dollar in the early 2000s led to the false commodities boom, the housing bubble and, ultimately, the panic of 2008–09. Other government mistakes played a part as well, especially the mark-to-market accounting rule applied to bank capital just before the financial crisis. That rule unnecessarily destroyed their capital when banks were most vulnerable. Once the policy was reversed in early 2009, following congressional pressure, the battered stock market rose dramatically.
Alas, another series of errors by the Fed–quantitative easing, Operation Twist and zero-interest-rate policy–have suppressed economic activity by thwarting customary flows of credit. Money was artificially directed to the federal government, Fannie Mae , Freddie Mac and large corporations at the expense of consumers and small and new businesses. Talk about trickle-down economics.
Photo Credit: Gage Skidmore