Skip to main content

Aggregate demand shortfalls and economic freedom

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.

This is a preview of subscription content, access via your institution.

Notes

  1. 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.

References

  • Barro, R., & Lee, J.-W. (2013). A new data set of educational attainment in the world, 1950–2010. Journal of Development Economics, 104, 184–198.

    Article  Google Scholar 

  • Bologna, Jamie, Andrew Young. (2015). Crises and government: some empirical evidence. Contemporary Economic Policy, forthcoming.

  • Bordo, M. D., Landon-Lane, J., & Redish, A. (2009). Good versus bad deflation: lessons from the gold standard era. In D. E. Altig & E. Nosal (Eds.), Monetary policy in low inflation economies (pp. 127–174). Cambridge: Cambridge University Press.

    Chapter  Google Scholar 

  • Caplan, B. (2003). The idea trap: the political economy of growth divergence. European Journal of Political Economy, 19, 183–203.

    Article  Google Scholar 

  • Christensen, Lars. (2013). Deflation – not hyperinflation – brought Hitler to power. The Market Monetarist, http://marketmonetarist.com/2013/11/17/deflation-not-hyperinflation-brought-hitler-to-power/.

  • Clark, J. R., Lawson, R., Nowrasteh, A., Powell, B., & Murphy, R. (2015). Does immigration impact institutions? Public Choice, 163(3–4), 67–78.

    Google Scholar 

  • de Haan, J., Sturm, J.-E., & Zandberg, E. (2009). The impact of financial and economic crises on economic freedom. In In Economic Freedom of the World 2009 Annual Report, James Gwartney and Robert Lawson. Vancouver, BC, Canada: Fraser Institute.

    Google Scholar 

  • Gwartney, J., Lawson, R., & Hall, J. (2015). Economic Freedom of the World. Vancouver, BC: Fraser Institute.

  • Hall, J. C. (2015). Institutional convergence: exit or voice? Journal of Economics and Finance, 44(4), 829–840.

    Google Scholar 

  • Hall, J. C., & Lawson, R. A. (2014). Economic freedom of the world: an accounting of the literature. Contemporary Economic Policy, 32(1), 1–19.

    Article  Google Scholar 

  • Hayek, F. A. (1931). Prices and production. London: Routledge & Kegan Paul.

    Google Scholar 

  • Hayek, F.A. (1973). Economic freedom and representative government. Institute for economic affairs occasional paper no. 39.

  • Heston, Alan, Robert Summers, & Bettina Atan. (2012). Penn World Table Version 7.1. Center for international comparisons of production, income and prices at the University of Pennsylvania. http://www.rug.nl/research/ggdc/data/pwt/.

  • Higgs, R. (1987). Crisis and leviathan: critical episodes in the growth of American government. Oxford, UK: Oxford University Press.

    Google Scholar 

  • Ikeda, S. (1997). Dynamics of the mixed economy: toward a theory of interventionism. New York: Routledge.

    Book  Google Scholar 

  • Laffer, Art. (2009). “Get ready for inflation and higher interest rates.” The Wall Street Journal, http://www.wsj.com/articles/SB124458888993599879.

  • March, R., Lyford, C., & Powell, B. (2017) Causes and Barriers to increases in economic freedom. International Review of Economics, 64(1), 87–103.

  • Marshall, M., Gurr, T., & Jaggers, K. (2014). Polity IV Project: Political Regime Characteristics and Transitions 1800-2013. Vienna, VA: Center for Systemic Peace.

  • Meltzer, Allen. (2014). How the fed fuels the coming inflation. The Wall Street Journal, http://www.wsj.com/articles/SB10001424052702303939404579527750249153032.

  • Mises, L. V. (2011). A critique of interventionism. Auburn: The Mises Institute.

    Google Scholar 

  • O’Brien, Matthew. (2013). Unveiled! Lenin’s brilliant plot to destroy capitalism. The Atlantic, http://www.theatlantic.com/business/archive/2013/09/unveiled-lenins-brilliant-plot-to-destroy-capitalism/280006/.

  • O’Reilly, C., & Powell, B. (2015). War and the Growth of Government. European Journal of Political Economy, 40(Part A), 31–41.

    Article  Google Scholar 

  • Rode, M., & Revuelta, J. (2015). The wild bunch! An empirical note on populism and economic institutions. Economics of Governance, 16(1), 73–96.

    Article  Google Scholar 

  • Sennholz, H. (1979). Age of inflation. Belmont, MA: Western Islands.

    Google Scholar 

  • Sumner, S. (2015). The Midas paradox: financial markets, government policy shocks, and the great depression. Oakland, CA: The Independent Institute.

    Google Scholar 

  • Wagner, R. (2014). Entangled political economy: a keynote address. Advances in Austrian Economics, 18, 15–36.

    Article  Google Scholar 

  • White, L. (1999). Hayek’s monetary theory and policy: a critical reconstruction. Journal of Money, Credit, and Banking, 31, 109–120.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Ryan H. Murphy.

APPENDIX A. Regression Results by Area of Economic Freedom of the World

APPENDIX A. Regression Results by Area of Economic Freedom of the World

Table 6 Area 1
Table 7 Area 2
Table 8 Area 3
Table 9 Area 4
Table 10 Area 5

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

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

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11138-017-0377-0

Keywords

  • Economic institutions
  • Voting behavior
  • Economic freedom
  • Macroeconomic political economy

JEL classifications

  • D72
  • E39
  • P16