Tuesday, July 19, 2011

Hayek and the Debt Ceiling

I think one can make a Hayekian argument for raising the debt ceiling.

Ignore for a moment that Hayek would have opposed the policies that created the need to borrow on a massive scale, ie: the government dissaving that drags down our national saving. Hayek's writing in Road to Serfdom and elsewhere tends to look at policy pragmatically--given the government has already enacted a sub-optimal policy, how best to deal with it, particularly without causing instability?

*this part updated for clarity*
Hayek is firm in his belief in what he terms the "Rule of Law." This is not the simple protection of property right and enforcement of law, as Hayek has already laid that out as a foundational role of government a classical liberal order. Hayek's Rule of Law is defined as (emphasis mine):
"(G)overnment in all its actions is bound by rules fixed and announced beforehand-- rules which make it possible to see with fair uncertainty how the authority will use its coercive powers in given circumstances and to plan one's individual affairs based on this knowledge. Though this idea can never be perfectly achieved, since legislators... are fallible men, the essential point, that discretion left to the executive organs wielding power should be reduced as much as possible is clear enough...rules tell people in advance what actions the government will take in certain types of situation, defined in general terms, without reference to time and place and particular people."

For Hayek, government changing a long-standing policy was a big deal because it would adversely affect people who had made individual choices based on the established rules of the game. A rule-based system is fundamental to a functioning market because it anchors expectations (emphases mine):
"(I)t does not matter whether we all drive on the left- or on the right-hand side of the road so long as we all do the same. The important thing is that the rule enables us to predict other people’s behavior correctly, and this requires that it should apply to all cases—even if in a particular instance we feel it to be unjust."

Discretionary macroeconomic policy were therefore anathema. One good example of this comes from Hayek's writings on monetary policy in the early 1930s. As Lawrence White writes,
"Hayek’s monetary policy norm in fact called for the stabilization of nominal income (MV), and thus for central bank action to prevent its contraction."

Monetary policy rules have been in the literature for a long time and Hayek has made his contribution. Given a fiat currency controlled by a central bank, the central bank should follow an announced and specific rule so that there is no deviation from expectations.

Now, the Fed pursuing such a policy in 2008 would still have led to a simple graph of M1 like this that would have bothered a lot of Rothbardian Austrians and Glenn Beck:
But as Scott Sumner and David Beckworth (and others) have spent the last few years arguing, if the Fed had an NGDP growth target, it didn't grow the money supply nearly fast enough to hit it during the financial crisis. Nor did the Fed keep inflation expectations in line with its implicit target of just under 2%-- it allowed them to fall far short. In other words, the Fed didn't live up to the markets' expectations of its behavior, and as a result we're still in a sub-optimal recovery.

So a Hayekian central bank under his Rule of Law definition would announce an explicit target of something and then consistently pursue it. (And pursuing that target in 2007-2008 would have led to policies like QE that would have made a lot of classical liberals uncomfortable.)

Hayek recognized that economic disturbances, if handled badly, caused the public to turn against free market capitalism. Hayek and Keynes were in agreement on this point. During the Depression, Hayek had argued for deflation and liquidation, but later regretted it in part because he saw the much worse political fallout.

While a staunch defender of the price mechanism, Hayek recognized that immediately removing England's wartime price controls would cause chaos and backlash against capitalism:
"(H)owever much one may wish a speedy return to a free economy, this cannot mean the removal at one stroke of most of the wartime restrictions. Nothing would discredit the system of free enterprise more than the acute, though probably short-lived, dislocation and instability such an attempt would produce." (emphasis mine).

Hayekian thought thus seems opposed to neoliberal (Jeffery Sach's) "shock therapy," eliminating any heavy wage/price controls and government interventions in the market immediately for countries that have adopted socialist practices. "Get it over all at once," as Sachs said in an interview. (One can argue that Hayek is vindicated by the observation of populist backlash against such capitalist reforms in countries like Russia after privatization was botched.)

Let's return to the debt ceiling debate. Congress has raised the debt ceiling 89 times since 1939. Judging by the yields on Treasury bonds today, the market expects the debt ceiling to be raised again and for Treasuries to keep their value. Like it or not, raising the debt ceiling is part of the Rule of Law that Hayek would expect the government to continue following. Deviating from those expectations would have consequences.

If the debt ceiling isn't raised, the President has to go through budget items line-by-line to figure out what gets funded and what doesn't. Thousands of jobs and incomes are immediately lost, interest rates rise, and the other economic consequences are quite costly. Given we already have a Federal Reserve that hasn't kept its obligation with the Rule of Law (and its Chairman indicates it's politically impossible for it now to do so), I would quote Hayek again here:

"Nothing would discredit the system of free enterprise more than the acute, though probably short-lived, dislocation and instability such an attempt would produce."

Defaulting on its debt, or meeting its debt obligations and cutting current expenditures dramatically to do so, could be as harmful to the long-run cause of free enterprise as the Great Depression was.

Default isn't being pursued or advocated by Hayekian Classical Liberals. It's being advocated by Conservatives who Hayek was very poignant about not being associated with.


Ken said...

Hayek did have a choice among continuing a socialist, central planning, agenda and a free market agenda. While your argument that he would rely upon the rule of law and aim for consistency in the debt debate is novel on a certain level, Hayek's actions indicate otherwise. He vacated Germany and moved to a "free-er" market driven England and then the USA to contend with the German (and Russian) socialists. Basically, he abandoned the system he could not change to aid and strengthen the systems he had a chance to aid and strengthen. You've placed Hayek in an impossible situation - and didn't even bother to ask him for permission! ;-)

You correctly, clearly, repeatedly, state that Hayek does not want to be associated with classic conservatism - but that does not mean he would be comfortable associating with modern liberalism. Classic liberalism was a move away from the divine right of kings and later feudal systems toward self-governance by some form of representation.

The central factor for Hayek is personal freedom - how a system can best be devised to ensure/facilitate/promote personal freedom. His emphasis on the rule of law (as few laws as possible) is to ensure one person does not limit the freedoms of another person. Hence, he supported policing, contract enforcement, etc.

Yes, he was pragmatic. But his pragmatism was based upon a sense of realism or feasibility. Pragmatism, for Hayek, was not a philosophical foundation.

May I suggest a comparative reading of John Rawls' "Political Liberalism," which provides a much more amiable support to the wealth redistribution enterprise?

JDTapp said...

"While your argument that he would rely upon the rule of law and aim for consistency in the debt debate is novel on a certain level, Hayek's actions indicate otherwise. He vacated Germany..."

Are you equating the debt ceiling debate with living in a totalitarian system? Or are you just saying he would have abandoned the U.S. long before now?

I don't argue that pragmatism was his philosophical foundation. But he repeatedly states that some government actions, while correct in principle (like eliminating rationing and price controls), could do more harm to the long-run cause of individual liberty due to the short-run chaos (namely unemployment) it would cause. Hence, he didn't advocate for immediate abolishment of all the socialistic controls which he abhorred.

I don't see the debt debate as much different. He wouldn't advocate the chaos a debt default would cause because of the same anti-market backlash that would result. (He wasn't a Randian nihlist.)

Hayek's Rule of Law idea was more than about one person not limiting the freedom of another. It's pretty clear (Pg. 112) that it's about anchoring expectations about what the government will due "given certain conditions." It was about eliminating "discretion," and was the foundation for his monetary policy prescription. You wouldn't want millions of of people adversely affected because the government suddenly did something that violated a clearly stated rule. I see that applying here. Since every leader of congress said last year the ceiling would be raised why shouldn't we recognize it as a clearly stated rule of the game?

What I have read of Rawls I find to be unrealistic. Will Wilkinson had a good post the other day about how Rawlsian equilibrium is unattainable because society is always inventing and adapting, constantly causing new rules to be necessary to achieve what Rawls wanted.

My guess is that he would be associated with self-proclaimed Hayekian "neoliberals" today, as well as "recalculation school" economists and whatever Austrians are currently calling themselves.

Fred said...

When Hayek was wrong in his political judgments and policy assessments he acknowledged it and changed his mind.

When "immediately removing Germany's wartime price controls" led immediately to an economic take-off, Hayek embraced & praised the policy.

This happened _after_ what he wrote earlier in _TRtoS_.

"Hayek recognized that immediately removing England's wartime price controls would cause chaos and backlash against capitalism."

Fred said...

This bologna, factually:

"Like it or not, raising the debt ceiling is part of the Rule of Law that Hayek would expect the government to continue following."

Raising the debt limit is NOT required to cover debt service -- and it's not even close.

JDTapp said...

Fred, nowhere did I claim that raising the debt ceiling was necessary for servicing the debt. Nor did I claim Hayek supported the wartime controls for all time. Please read the post in its entirety.

JDTapp said...

I modified the post to extend the Rule of Law quote. Hayek repeatedly remarks that the adverse effects of any change in government policy is something to be taken seriously. Thus, government should change its policies very infrequently and never without announcing it well beforehand. Discretionary policy was out.
Hence, if it has always raised the debt ceiling and announced that it will do so again (as all leaders of congress have, and as the market now believes), failing to raise it was a violation of Hayek's definition of Rule of Law.

Ken said...

Hayek clearly referred to freedom of individuals in his work.

"From the two central features of every collectivist system, the need for a commonly accepted system of ends of the group and the all-overriding desire to give the group the maximum of power to achieve these ends, grows a definite system of morals, which on some points coincides and others violently contrasts with ours - but differs from it in one point which makes it doubtful whether we can call it morals: that it does not leave the individual conscience free to apply its own rules and does not even know any general rule which the individual is required or allowed to observe in all circumstances. This makes collectivist morals so different from what we have known as morals that we find it difficult to discover any principle in them, which they nevertheless possess."

"The difference of principle is very much the same as that which we have already considered in connection with the Rule of Law. Like formal law, these rules of individualist ethics, however unprecise they may be in many respects, are general and absolute; they prescribe or prohibit a general type of action irrespective of whether in the particular instance the ultimate purpose is good or bad. To cheat or steal, to torture or betray a confidence, is held to be bad, irrespective of whether or not in the particular instance any harm follows from it. Neither is the fact that in a given instance nobody may be the worse for it, nor any high purpose for which such an act may have been committed, can alter the fact that it is bad. Though we may sometimes be forced to chose between different evils, they remain evils." (Hayek/Road, 166)

While if may be interesting (soothing?) to ponder how Hayek might support the current tax & spend policies of recent US administrations, he would not do so on the grounds of a growing state - of which he vehemently disapproved. How would he respond, ralistically? By writing and lecturing against the increasing debt, by identifying specific programs he believed are beyond the scope of classic liberal views of government, by vacating a political party (or parties) that has/have become unmoored from its foundational principles, and by updating The Road to Serfdom to include contemporary examples of how collectivist action in the USA further encroaches upon individual rights.

Pour Professor Hayek a cup of fresh, hot tea, please.

JDTapp said...

That Hayek shares many Tea Party values is not in dispute. My point is that the evidence from Road to Serfdom says he'd disagree with their official position-- that defaulting on the debt, or cutting 70% of government services to service the debt, causing a dramatic adverse shock to the economy--is good for their cause.

Many prominent Tea Partiers are invoking his name in vain when advocating technical default.

JDTapp said...

Worth noting that Fred who commented above runs a site devoted to Hayek and noted via Twitter that:
"I don't know what Hayek would advocate in this special case. Most likely he wouldn't take a position due to lack of knowledge."

I retorted: "Kind of like Mitt Romney."

JDTapp said...

Russ Roberts (George Mason) also opines on Hayek, the debt ceiling, and the Tea Party.

"The Tea Party is friendly to Hayek, but I don't know if Hayek would be friendly with them..."