No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eighteen: The “macro” view of the economy 464 increase in government spending. Where does the government get the resources to increase spending? It can do one of three things: tax, borrow, or inflate (print money). If the government taxes to fund its expenditure, it is going to cause the taxpayers to reduce their consumption and/or reduce their savings (which will lead to an increase in interest rates), which reduces private sector investment. If the government borrows to fund the deficit, those funds would have otherwise been available for private sector investment, which will cause investment to be lower than it otherwise would have been. Finally, if the government prints money, this will result in inflation—reducing private sector consumption and investment in real terms. This impact on the private sector consumption and investment is often called crowding out , since the government action is going to necessarily come at an opportunity cost of private sector resources. So will the stimulative effect of government spending outweigh the reduction in private sector activity? We are left with the same unsatisfactory answer as above: that would ultimately be an empirical question. In a very weak economy with many idle resources, it may well not have much of an opportunity cost. As the economy is relatively stronger, the opportunity cost of an associated crowding out of private sector activity is greater. Since there is a question as to which effect is likely to dominate, the appropriate way to think of government spending may simply be: is the value of the government goods and services spent to stimulate the economy more valuable than what the private sector could have done? While necessarily a speculative and subjective question, the question does have the benefit of correctly identifying the crucial issue from an economic point of view: what are the costs and benefits of any proposed course of action? This is the heart of economics, and should be the heart of macroeconomics as well. IT’S A WRAP! Doubly so, since you’ve just finished the chapter and the 3rd Edition of No Free Lunch ! In this chapter we’ve learned about some of the complexities of macroeconomics, which help explain why it’s so difficult for macroeconomics to succeed in its goal to be a predictive science. We’ve covered the main macro variables you’ll see in media when the economy is discussed, and you know why unemployment is only part of the story or our labor market as well as why growth should be a key consideration regardless of your political persuasion. You know the difficulties of trying to manage the demand side of the economy by government spending and some of the ways that policymakers can alter incentives on the supply side. In a chapter like this, we can only scratch the surface of a subject like macroeconomics, but you should be able to converse intelligibly on many of the economic issues of the day. But remember an adaptation of a quote used supposedly by Otto Von Bismark in speaking about Russia (“Russia is never so strong or as weak as she appears”), “Economics is never so difficult or as easy as it appears.” You can understand many powerful truths through the simply analytical technique of supply and demand. But you need to keep after it—the world is full of economic fallacies. Crowding out: the impact on the private sector of inflation from the government printing money, which reduces private sector consumption and investment