An article I saw recently [once again, can’t find link] commented that an economy experiences recession when its domestic consumption and investment have fallen below capacity. That leaves essentially three options for recovery. (1) Government can step up spending to make up for the gap in the private sector. (2) The central bank can expand the money supply to lower interest rates and encourage more borrowing and investment. (3) The currency can fall to make exports cheaper and make up the drop in domestic production by exporting more.
All three options have some tendancy to occur spontaneously. A shrinking economy causes revenues to drop and unemployment payments to rise, forcing government to borrow more to make up for the lack of private borrowing. Lack of private borrowing tends to make interest rates drop and thereby make government borrowing easier, even in the absence of action by the central bank. And currencies of distressed economies fall, boosting exports. The point of the article was that the European Union is hard at work cutting off all three options for distressed members. Another point may be that conservatives seem determined to cut off all three options in all circumstances.
I understand the first one very well. If you regard all government spending as a great evils, then naturally you will regard increased government spending to boost the economy as a monstrosity. The second one is a little more difficult, but not too hard to understand. A central bank, though an independent agency, is ultimately part of the government, so monetary expansion is still government intervention in the economy. Besides, conservatives are famously inflation averse, and monetary expansion is, after all, inflationary, or at least potentially so.
But what is the problem with currency devaluation? It doesn’t call for government action, just for government sitting by and letting nature take its course. And it revives the economy, not by actions in the public sector, but by a private sector boost from exports. Indeed, one of the earliest and strongest champions of flexible exchange rates was no less a conservative and libertarian than Milton Friedman.* Friedman argued as far back as 1953 that it made more sense for exchange rates to adjust to the needs of an economy than the economy to adjust to maintain a fixed exchange rate.
Why floating exchange rates would appeal to liberals is straightforward enough. I read the case clearly made in college by a Keynesian writing in 1951. His words were, “We cannot have fixed exchange rates, full employment, and free trade. We can have any two, but not all three.” This was two years before Friedman warned of the dangers of fixed exchange rates. About a decade later, Robert Mundell made the case that these three items are the impossible trinity. He, too, believed that if one had to go, it was fixed exchange rates. So, if you value being able to fight recessions with expansionary policies (fiscal or monetary) you would prefer not to have your hands tied by maintaining a fixed exchange rate. The ability to fight recessions is a high priority for liberals. If that means fixed exchange rates have to go, so be it.
By contrast, conservatives are more driven by fear of inflation. I suppose this might partially explaint conservative fondness for fixed exchange rates -- as a barrier against inflation. Certainly during the same research in which I found the Keynesian quoted above, I also saw a work by a conservative Briton writing in the late 1960’s, a time when his country really had gone too far in fighting unemployment with fiscal and monetary expansion and was developing a serious problem with inflation.** He pitched fixed exchange rates as a necessary discipline to prevent inflationary policies.
But what if inflation is not a big problem? What if the big problem is recession (or even depression), rather than inflation? Even if the goal is to tie governments’ hands and keep them from intervening to fight recession, fixed exchange rates do not, after all, prevent government intervention in the economy. They simply replace intervention to fight recession with intervention to maintain an exchange rate. What’s so free market about that?
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*Of course, these days Friedman is looking more and more like a lefty on macro issues.
**US inflation in the 1970’s peaked around 13% annually. British inflation peaked at about twice that rate, or 27%.
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