What is the proper role of government in times of economic crisis?


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The consensus opinion among the vast majority economists about the government's role in the time of economic crisis is Keynesian—that the federal government is there to prop up the situation by providing support and stimulus. The role of any responsible modern nation-state during an economic crisis is to lower interest rates and pump money into the economy when demand for goods and consumption of goods drops off sharply. Otherwise, economies collapse, leading to widespread suffering and instability.

We have governments for a reason, not simply because they are a fact of nature like the sun or the moon. They are expensive and cumbersome and never manage to please everyone. Nevertheless, we finance and put up with them because they are a social good, and they protect (or should protect—that's what we are paying for) the general well-being of a nation. A chief part of that is doing everything they can to promote economic stability and widespread prosperity so a nation can be strong and secure.

We have seen Keynesian economics—or something similar to it (Keynes would no doubt argue about how the money was dispersed)—jump into high gear in recent times as the US economy has collapsed due to coronavirus. The Keynesian solution—pumping a huge amount of money into the economy to keep it afloat—was adopted as a bipartisan approach. Republicans and Democrats were not arguing about this as a fundamental approach: everyone united around this necessity. The Federal Reserve also did the classically correct thing: they cut interest rates. This is sound policy.

We are long past the days, at least for the vast majority of economists, politicians, and the public, in which a moral hazard is ascribed to government intervention to save a failing economic system. Letting a failing economy "self correct" would be like watching a person have a heart attack and doing nothing, thinking it would undermine the person to intervene. Like the heart attack victim, a swooning economy needs a "jolt" to get it going again.

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There is considerable debate on this question among various economists.

The general mainstream view is called the New Neoclassical Synthesis: Based primarily on the work of John Maynard Keynes, it says that the government has a vital role to play in stabilizing the economy during times of crisis by two basic methods.

The first is monetary policy, the decision of the central bank as to what target interest rates to set, which determines the amount of money in circulation. When the economy is in recession, the central bank should lower interest rates to increase the amount of money in circulation and thereby offset the recession.

The second is fiscal policy, the decision of the government as to how much to spend and how much to take in taxes. During recessions, especially very severe recessions where monetary policy is insufficient, the central bank should run a cyclical deficit, spending more money than they take in taxes, in order to increase the demand for goods and lift the economy out of recession. Then, once full employment is restored, they should balance their budget or even run a surplus in order to pay down the debt they incurred in the recession.

This is the mainstream view, but there are many economists who believe that it is no longer adequate. At the extreme left there are Marxian economists who believe that the government should take a great deal of control over the economy; at the extreme right there are Austrian economists who believe that the government should have almost no involvement in the economy whatsoever. There are also alternative centrist views, such as those that apply insights from behavioral economics to understand the causes of recessions and find better ways to prevent them or respond to them.

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