Question

Explain how a liberal and conservative would approach developing the US budget. Use evidence (cite sources) to support your response

Answer 1

Ans: 1) Sources of Economic Instability:

- Conservatives generally favor free markets and consider government interventions in these markets as the major source of all economic instability.

- Specifically, governments are accused of creating uncertainties by their constant changes in economic policies and regulations, thus making it harder for private businesses to effectively plan their future activities.

- In addition, benevolent but misguided government policies, such as attempts at wider home ownership, imposition of minimum wages, and excessively easy monetary policy, create conditions that may have temporary benefits, but will result in unintended and harmful long term consequences.

- This explains why many conservatives blame governments and their housing policies for the current global financial crisis. For liberals, on the other hand, it is the combination of unbridled free markets and their private sector participants which causes all our economic problems. It is the private sector which creates all recurring booms and busts in the economy through excessive leverage and speculation, thus necessitating frequent government bailouts and stabilization policies. This is why many liberals currently point to private speculators and their greedy financiers as the main culprits behind the latest housing crash and its recessionary consequences.

2) Rules versus Discretion in Economic Policy:

- Conservatives, skeptical about governmental ability to gather relevant and timely economic data and their use in implementing appropriate discretionary policies, prefer automatic policy rules, such as balanced budgets, fixed money supply growth rates, flexible exchange rates, and market-determined incomes.

- Such rules are expected to provide a more predictable environment, compared to erratic discretionary actions that may only serve to confuse businesses and, thus, to further destabilize the economy. In addition, conservatives particularly dislike all types of income and wealth redistribution policies, misguided and counterproductive attempts to reward the unproductive “takers” and to punish the productive “makers.”

- In contrast, liberals reject all automatic policy rules, as they consider modern economies vulnerable to a host of random shocks, such as wars, commodity price movements, and disruptive technological advances. Under these conditions, which could adversely affect production and employment levels, liberals favor a more hands-on policy approach, not unlike the situation of driving along a winding road with both hands on the wheel, as using the cruise control can prove hazardous. Hence, the argument by liberals that if the Fed had heeded the conservative call for a fixed money growth rule during the crisis of 2008, the rush to liquidity by panicked investors would have severely lowered asset prices and, therefore, irretrievably damaged the financial system.

3) Fiscal versus Monetary policy in Economic Stabilization:

- Conservatives generally favor monetary policy as a stabilization tool, as they consider fiscal actions as synonymous with spending on wasteful social programs, budget deficits, government borrowings, higher interest rates, and the crowding out of useful private investment.

- Liberals, in contrast, consider monetary policy too slow and weak to address sudden and drastic declines in aggregate demand in the economy. Specifically, liberals point out that lower interest rates generated by easy monetary policy will fail to stimulate the economy, as many borrowers will be reluctant to add to their debt loads during hard economic times.

- Instead, liberals tend to favor more public spending on infrastructure, education, unemployment benefits, and similar demand-boosting projects. The relative impotency of monetary policy during the recent crisis to create a meaningful economic recovery is often cited by liberals as a case supporting their position.

4) Causes of Inflation:

- To conservatives, inflation is always and everywhere caused by excessive monetary expansion, that is, by too much money chasing too few goods. Liberals largely reject this inflation model as being applicable only to the third world countries.

- In these countries, printing of money is often used by governments as a substitute for tax revenues, thus generating too much demand for goods and services, which in the face of supply limitations, can create inflationary pressures. In modern industrial countries, however, where there is a general tendency for over-production, inflation is mainly caused by increases in production costs, such as wages and commodity prices.

- In addition, during deep recessionary periods, such as we are experiencing right now, production costs rarely increase, thus keeping inflation at bay. As evidence, liberals point to the experience of the Great Recession, during which many central banks massively increased their money supplies and thus, to believe conservatives, subjected their economies to the immanent threats of hyperinflation. In reality, of course, as liberals keep asserting, the bulk of the newly created monies seems to have been hoarded, with no appreciable impact on inflation rates.

- Needless to add, home prices in some US cities, especially those in the South or on the Coasts, have begun to rise as a result of the energy boom and real estate speculation. But again, according to liberals, given the backdrop of the generally weak US economy, this housing boom can only be short-lived.