Keynes vs. Hayek (Cochrane)

John Cochrane reminds us who won the policy debates of the 1930's:

Most fiscal stimulus arguments suffer from three basic fallacies.

First, if money is not going to be printed, it has to come from somewhere. ... Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. ... But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes. Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.

Instead of fiscal stimulus, Cochrane advises us to rebuild credit markets:

The first step is to stop chaotic interventions. Who would buy bank stock, lend long-term, or buy securitized debt, knowing that the government might rewrite the rules at any point? Second, the government must focus on the policy issue, which is making sure new savings can flow to new borrowing, not who takes the hit for old bad loans.