Friedman, Milton

Now That Everyone Is Bullish, Be Cautious

As businesses shuttered and workers stayed home, the gross domestic product, a broad measure of goods and services, plummeted in the United States. G.D.P. dropped 5 percent in the first quarter of 2020 and more than 31 percent in the second, according to the federal Bureau of Economic Analysis. The unemployment rate surged more than 10 percentage points from March to April last year, nearly reaching 15 percent. That was the highest level and the biggest increase since the Bureau of Labor Statistics began collecting data in January 1948.

In March 2020, the Federal Reserve stepped in. On its own, it couldn’t do much to combat the coronavirus itself — the last presidential administration’s efforts were dilatory at best, historians say. But the Fed and the federal government were able to prop up the markets, provide emergency aid for millions of people, help keep at least some small businesses afloat and put most major corporations in a position to reap big profits as the economy rebounded.

By now, the federal government has committed more than $5 trillion in a variety of coronavirus-related aid packages, and the Fed has made trillions more available in loans, intervened in financial markets, purchased vast quantities of bonds and held short-term interest rates near zero.

The Biden boom

All of this is contributing to what looks like a “Biden boom economy,” as the Princeton economist Alan S. Blinder called it in The Wall Street Journal. Economic growth may exceed 7 percent for the first quarter, and will almost certainly be spectacular for the year as a whole, when compared with 2020.

But there’s the rub. These annual economic and financial numbers are comparisons with the depths of the pandemic. The statistics are warped, inevitably, by “base effects,” which is to say, in economic jargon, that the coronavirus-induced recession of last year is making many current numbers look unnaturally high. They don’t provide much insight about where we are heading in 2022 and later.

Take inflation, for example

As Neil Irwin explained in The New York Times, the current uptick in inflation may not be as worrisome as it would otherwise seem because its comparisons are based on the depressed prices of a year ago, when so many people were huddled indoors.

What’s more, Alberto Cavallo, a Harvard economist who has studied inflation deeply, told me that by altering consumption and supply patterns radically, the pandemic has had many subtle effects. Lower-income people, for example, who pay a higher proportion of their income for food, have experienced greater inflation than those for whom food is a relatively minor expense.

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Why the Markets Need a Strong Government Hand

More to the point, there is also substantial waste in the private sector, much of it caused by individual purchase decisions that impose costs on others.

Suppose, for example, that everyone owned a car weighing less than 2,500 pounds and someone then bought one that weighed 5,000 pounds. That person would face less risk of injury and death than before, while all others would face more. Their best response may be to buy 5,000-pound cars themselves, in which case everyone’s risk would be higher than when all were driving smaller cars.

Similarly, at crowded gatherings in enclosed spaces (remember them, before the pandemic?), when all speak more loudly to hear better, they don’t hear as well as they would have if all had spoken more softly.

In these cases, individually rational behavior is collectively irrational. Buying 5,000-pound cars when 2,500-pound cars would be better for almost everyone is waste, pure and simple.

Taxing vehicles by weight would be a relatively unintrusive remedy. But opponents of government might object, saying such measures are social engineering. Yes, but so are speed limits and traffic lights. Policies that try to bring individual and collective interests into closer alignment exist in all countries, for good reason. And as long as we have to tax something, why not tax activities that cause harm to others? Every dollar raised from such levies can be a dollar less from the many taxes currently imposed on beneficial activities.

Former President George W. Bush once said, “We don’t believe in planners and deciders making decisions on behalf of Americans.” Yet that’s exactly what all societies entrust government bureaucrats to do, again for good reason: Even if people are just as rational and markets just as competitive as Mr. Friedman believed, individually rational actions often yield demonstrably bad outcomes. That simple, incontestable fact has always been the central rationale for government involvement in economic life.

The government requires catalytic converters on cars, for instance, because each individual’s decision to install one would be costly and yield no measurable impact on air quality. Yet when everyone installs a catalytic converter, the benefit of the improvement in air quality far outweighs the corresponding cost.

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