Abstract
Political instability is often exacerbated in periods of aggregate demand shortfall. It has been conjectured that inadequate policy responses to recessions may be inimical to free economic institutions. This paper uses the Economic Freedom of the World index as its measure of economic institutions, and finds that the change in economic freedom in the following five, ten, and fifteen years is negatively impacted by an aggregate demand shortfall as measured by negative NGDP growth.
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Notes
The precise mechanism by which this may occur is not developed in this paper explicitly beyond the description of the narrative. Sumner’s description (2015: 398) follows, comparing policies in the Great Recession in America to recent day Argentina:
[Argentina] adopted the dollar peg in the early 1990s as a reaction to its experience with hyperinflation (recall 1920s Europe). And Argentina experienced deflation in the late 1990s and early 2000s as the real value of the dollar rose in the foreign exchange markets (recall the real appreciation of gold after 1929). And Argentina hung onto its dollar peg until the economic pain was so great that a new and more left-wing government decided to devalue its currency and tear up promises that debts would be convertible into dollars (recall FDR revoking the gold clause). And the left-wing government moved away from the neoliberal policies that they wrongly thought also contributed to Argentina’s problems (recall the NIRA). And the powerful expansionary effects of the devaluation helped cover up the drag on the economy that normally would have resulted from the adoption of more statist policies (recall the U.S. recovery after 1933). The point is often overlooked; if depressions do encourage statist policy interventions, then deflationary policies may impose costs that are much larger than those predicted by natural rate models of the business cycle.
In a footnote, he continues,
The extraordinarily large and wasteful public works expenditures undertaken during the recent Japanese deflation are another example of this phenomenon. The most dramatic example of nominal shocks leading to harmful policies is World War II, which might have been avoided had the Great Depression not occurred.
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APPENDIX A. Regression Results by Area of Economic Freedom of the World
APPENDIX A. Regression Results by Area of Economic Freedom of the World
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Murphy, R.H., Smith, T.L. Aggregate demand shortfalls and economic freedom. Rev Austrian Econ 31, 111–122 (2018). https://doi.org/10.1007/s11138-017-0377-0
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DOI: https://doi.org/10.1007/s11138-017-0377-0