If there is an iron law in politics, it’s that when crisis hits, government grows. Rahm Emanuel, President Obama’s chief of staff, advised that politicians should never let a crisis go to waste. And when the crisis passes, government almost always hangs on to some of its new emergency powers. The economic historian Robert Higgs calls this the ratchet effect. Politicians might give back some of their new powers, but not all of them.
We’ve seen it before. And, while past power grabs are likely here to stay, there is a way to dampen future “flash policy” crisis responses: a comprehensive, government-wide Abuse-of-Crisis Prevention Act.
The need for such a law is urgent. Already this century, there have been three crises, with three rounds of abuses. The September 11 terrorist attacks spawned the PATRIOT Act, the Department of Homeland Security and Transportation Security Administration, and two of the longest wars in American history. The 2008 financial crisis gave us too-big-to-fail, Dodd-Frank financial laws, and America’s largest stimulus spending spree up to that point.
The Covid-19 pandemic is the 21st century’s third crisis. Both parties smashed previous spending records and centralized more power in Washington than ever before. Spending on projects such as infrastructure and climate change reached into the trillions, with commitments to spend more over the next decade. Supply chains already strained by regulations and trade barriers reached a breaking point, and the policy response has been to add even more to those burdens. Today’s high inflation is also a direct result of the Federal Reserve’s emergency Covid response.
Our new Competitive Enterprise Institute paper puts forward ideas for an Abuse-of-Crisis Prevention Act. It is not enough to reform individual regulations or spending programs. The rules of the game itself are broken. Here, we stick to two reforms that have a common theme: Institutions matter.
First, along with concentrated, prerequisite efforts to drastically shrink the federal government’s spending and regulatory reach, households, businesses, states, and localities can be greatly empowered to establish “rainy year” funds via tax code changes and more, enabling reserves on hand when crisis hits. For example, we now know that “reasonable needs” with respect to retained business earnings for income-tax purposes must expand to include preparation for crisis instead of demanding bailouts. And as an alternative to stimulus checks, households allowed to tap new “rainy year” funds — convertible to retirement — will be in a better position to help others while needing less help themselves. Removing obstacles to saving and investment can greatly expand resilience on the part of the public and businesses.
In addition, states must rediscover sovereignty to prep for the next crisis. Shockingly, federal grants to states topped $750 billion even before the pandemic, according to the Congressional Research Service. There is no need for these taxpayer funds to make a useless orbit around the Beltway. States, with a freer hand, but also knowing that no federal bailout is forthcoming, would have a much stronger incentive to rein in their own spending and build rainy-year reserves and stockpiles.
Nobody knows what the next crisis will be, or when it will hit. But we do know there will be one at some point and that governments will respond to it with massive spending. There is no need to create surprise debt for something everyone knew could happen. Governments should save up during good times to give themselves more flexibility during the bad times, without hoarding investment capital at the worst possible time.
Second, bind the Federal Reserve to a monetary policy rule. The Fed informally followed a Taylor rule during the low-inflation Great Moderation from the 1990s through 2007, which attempts to moderate business cycles by raising interest rates during booms and lowering them during busts. But the Fed abandoned this rule during the financial crisis and in its panic caused a brief deflation. That mistake turned what could have been an ordinary recession into the worst downturn in seven decades.
Discretion also let the Fed bungle its Covid response. GDP is now roughly where it would have been had Covid never happened. There was no need for monetary stimulus on that scale; a mostly healthy economy closed down until it was safe to open back up. The Fed instead grew the money supply by about a third in a panicked stimulus attempt. The mismatch it created between the money supply and real output is the main cause of today’s inflation.
Binding the Fed to a rule would prevent these crisis shenanigans. It’s less important what that rule is, than for there to be one. There are good arguments for and against various approaches (NGDP targeting, monetary growth targeting, a Taylor rule, and others), but each one offers predictability and stability. Rules-based monetary policy would empower the Fed to say no to politicians seeking stimulus during a crisis or an election year, while reining in ambitious and ideologically motivated Fed appointees.
Rainy-year funds and the rule of law in monetary policy are just two ways to prevent abuses of future crises. People have already suffered enough this century from terrorist attacks, a financial crisis, and a pandemic. Hasty, expensive “flash policy” made things worse each time. When the next crisis hits, people will be better off if they have some institutional safeguards against flash policy. The time for an Abuse-of-Crisis Prevention Act is now.
Read the full article here.