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Monday, October 27, 2008

Panic decisions tend to be bad decisions

Arthur Laffer isn't my favorite economist, but he has a good point here about decisions made under stress:

I was on the White House staff as George Shultz's economist in the Office of Management and Budget when Richard Nixon imposed wage and price controls, the dollar was taken off gold, import surcharges were implemented, and other similar measures were enacted from a panicked decision made in August of 1971 at Camp David.

I witnessed, like everyone else, the consequences of another panicked decision to cover up the Watergate break-in. I saw up close and personal Presidents Gerald Ford and George H.W. Bush succumb to panicked decisions to raise taxes, as well as Jimmy Carter's emergency energy plan, which included wellhead price controls, excess profits taxes on oil companies, and gasoline price controls at the pump.

The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 years.


The point is that panicky decisions are often poor ones with unintended consequences.

In 2008 our government is making a staggering variety of complex financial decisions under even more panicky cirucmstances. A lot of them are self-contradictory: if part of the problem is that some banks are "too big to fail", it's contradictory to make these banks even bigger -- even though that seems the best strategy for now, to avoid overloading the FDIC funds.

Almost certainly, there will be a mess of unintended consequences to clean up for decades.

[I'm not sure August of 1982 counts as pre-Reagan, given that Reagan entered office in January, 1981; Laffer seems a little sloppy here.]