TJP

Socializing Inefficiency: Wall Street Bailout

By Byron A. Ellis - October 18, 2008

Efficient financial markets are essential for capital formation and economic growth; they channel savings from savers to borrowers satisfying the highest level of want. The current financial crisis is indicative of many inefficient financial actors.

The government, however, has seeing it fit to subsidize inefficient financial actors with $700 billion dollars of taxpayers’ money. However, allowing inefficient financial firms to survive is unlikely to lead to efficient financial markets.

Many of these financial firms misallocated funds from savers to borrowers merely capitalize of transaction fees. When capital is misallocated, economic growth is restrained or becomes totally stagnant.

Ineffectively allocated capital adversely affects national income, real standard of living, and national security.

The current economic crisis is indicative that governmental agencies failed to properly regulate the financial market. It is also clear that the government failed to balance the supply of money in the economy, which would have increased national income.

The government can use fiscal and monetary tools to balance the supply of money in the economy. More money in the economy would increase income and buying power, preventing many foreclosures and troubled mortgages.

When the economy is contracting, an expansionary policy is an appropriate remedy. However, policy makers, including the Federal Reserve (Fed) failed to foresee the adverse effect of rising energy prices. And, foolishly argued that the economy could absorb rising crude oil prices.

The economy has seldom, if ever, absorbed rising energy prices. Rising energy prices has always caused a slowdown in the economy.

The Fed is a quasi-autonomous government agency that can increase the supply of money in circulation. Of course, expanding the money supply could lead to adverse consequences, such as inflation and currency devaluation in an expanding economy.

Republicans tend to believe that stimulating supply, proving incentive to businesses, is the answer to economic growth. This view of macroeconomics is known as trickle-down economics.

Many Democrats, on the other hand, follow a more Keynesian view of the economy; they believe that increasing demand, not supply, increases economic growth. As a result, they focus on targeting the middle class and lower income earners.

The response to the current crisis is typical trickle-down economics. Thus, it is unlikely to have any positive effect on the incomes of middle and lower earners and hence it is not likely to increase demand.

What is likely to increase demand is the fall in crude oil price. Crude oil prices have decreased significantly because futures crude oil trades are unwilling to bet on higher crude oil prices. And, as the price of energy falls, consumers’ real income increases allowing greater demand for goods and services.

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