Friday, August 27, 2010

How can we fix the economy?

There is no easy solution, especially not one that the government can perform. Essentially, the recession is a readjustment to economic reality. We created a giant housing bubble that did not truly represent real demand for housing. We must, then, let housing prices fall and let banks that issued bad mortgages go bankrupt. We must let productive resources that were funneled into housing be shifted into other industries. This will lead to short-term pain. Some companies will fail, even some that do not appear to be directly related to the housing bubble.

Yet, as long as we do not put government obstacles in the way of restructuring our economy, the recession and its unemployment will not go on for very long. Attempting to "fight" the recession through government stimulus will only prolong the agony. The two largest attempts to do so in American history were the 1930's and the 1970's, both of which had poor economic growth and persistently high unemployment. The government should instead cut spending, cut taxes, and remove any obstacles to the economy's restructuring, such as bailouts. This is the only way to ensure a relatively quick recovery and minimize the pain.

Moreover, we need to eliminate the incentives that got us into this crisis. We should not use the Federal Reserve to lower interest rates as stimulus policy, as this necessarily blurs economic forecasting and leads to bad investments, just as lowering interest rates in the wake of the dot-com bust led to our housing bubble. We should completely end bailout policies and expose the idea of "too big to fail" as the fiction that it is. We should recognize that government subsidies lead to imbalances that are eventually exposed in crises and attempt to eliminate them all, allowing the market rather than the government to coordinate resources.

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