Economists understand (or should) the distinction between what often is true or desirable in the short run and what is true or desirable in the long run. Examples are how an expansive monetary policy affects interest rates and employment, how currency depreciation affects a country’s balance of payments, and how a tax change affects government revenues. Even many laymen understand “moral hazard,” especially how government rescues of “too big to fail” firms encourage excessive risk-taking and cause the apparent need for further and bigger bailouts later on.
Too often, though, the short vs. long distinction escapes pundits and policymakers, including politicians seeking reelection. So-called Keynesian policies to boost spending may alleviate recession in the short run, but at longer-run cost. The “stimulus” of government deficit spending, if it works, wastes resources on projects not worth the cost in other public and private activities crowded out. The “cash for clunkers” program and the subsidy to first-time homebuyers shift demand forward in time (while incidentally redistributing wealth not to really poor people but to people well enough off to afford cars or houses). If an increased government deficit is a (short-run) good idea, sending a $250 check to old people is not as good a way of increasing it as cutting marginal tax rates to improve incentives. (But perverse though the program is, I won’t send my own check back.)
Appraising measures to promote business recovery should take account of what a recession is. When Vice President Biden and other spokesmen claim that their “stimulus” program has created millions of jobs – or, rather, has saved many jobs that would otherwise have been lost – they are making a claim rendered empty by its built-in protection against being proved wrong. Commentators show impatience when they report the failure of the Federal Reserve’s currently very easy monetary policy, forgetting Milton Friedman’s explanation of why monetary policy typically works with long and variable lags. The task of reversing the Federal Reserve’s vast creation of bank reserves in time to prevent severe inflation, or even a panicky flight from the dollar, is another example of short-run vs. long-run contrast.
A recession is a disruption of the intricately coordinated nationwide, even worldwide, web of buying and selling, employing and working, and lending and borrowing that links business firms to one another and to workers and consumers. Time, not government, brings recovery as firms and people grope for a new market-clearing pattern of prices and wages and as they restore or replace disrupted business relations – all on condition that a perverse monetary policy does not impede this mending of contacts. Regrettably, employment is usually one of the last signs of business recovery.
Capricious experimentation with measures to restore prosperity threatens to impair business confidence in the longer run and so the investment that would bring greater production and employment. New Deal measures, for example, prolonged the Great Depression of the 1930s until the start of World War II.
The viewing and reading public provides another example of short-run orientation when it demands and seems to take seriously the many mutually contradictory stock-market predictions supplied every day on TV and in the newspapers. Their unreliability is encapsulated in the old maxim (attributed to various skeptics): “If you must predict, predict often.”
