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The Public Policy
We’re All Keynesians Again
If only Keynesians knew their own history.
John Maynard Keynes is fashionable again, thanks at least in part to President Barack Obama. Obama’s economic team features economists like Larry Summers, whom the BBC termed a “pugnacious Keynesian.” Yet Obama’s team maintains a centrist reputation within academia, avoiding the liberal label despite their Keynesianism.
This reconciliation of the ideas of Keynes, the father of progressive economics, with the mainstream would not have been respectable 30 years ago. “Keynes has become a dirty word to many people,” wrote Robert Skidelsky, the noted biographer of Keynes, in the August 1981 issue of The American Spectator. “The easiest way for any economist to make a name for himself is to attack the fallacies of the Keynesians.”
What precipitated Keynes’s comeback from dirty word to White House savior? Dr. Bruce Caldwell, an economic historian at Duke University, noted the key to Keynes’s recent popularity: “[Keynes’s] theory, by providing a theoretical justification for action, is custom-made for a crisis. ‘Don’t just sit there, do something’ is a universal human instinct when times get bad.’”
Franklin Delano Roosevelt succumbed to this instinct during the Great Depression. Keynes’s unorthodox ideas regarding deficit spending provided the basis for the New Deal. On December 31, 1933, Keynes spelled out, in an open letter to FDR, the underpinnings of his style of crisis economics. He suggested that the purpose of the New Deal should be twofold: recovery and reform. The latter could wait, though. The former involved immediate massive debt-financed spending, by hook or crook. How the money was spent didn’t matter too much: “the object is to start the ball rolling. The United States is ready to roll towards prosperity, if a good hard shove can be given in the next six months.”
The logic behind Keynes’s “good hard shove” was further developed in his masterpiece, The General Theory of Employment, Interest, and Money, published in 1936. Keynes’s basic insight is that in recessions pessimistic consumers and businessmen hoard cash and refuse to spend no matter how low interest rates become, rendering monetary policy useless. The solution to this “liquidity trap” is for the government to offset the lack of demand for goods and services with public spending.
The common wisdom, for a long time, was that FDR’s New Deal public spending ameliorated the Great Depression and World War II defense spending defeated it. Now, however, economic historians are divided on the subject. By and large, economists subscribe to Milton Friedman’s thesis that monetary policy drove both the Depression and its recovery.
Other historians, such as Robert Higgs and Amity Shlaes, have advanced the argument that the government’s unpredictable interventions into the market impeded private-sector planning, and that the New Deal was mostly ineffectual or counterproductive. But the idea that inaction is unthinkable in the face of a crisis remains powerful today. Confronting an apparent liquidity trap, the Federal Reserve has taken Friedman’s monetary critique to heart and lowered interest rates to zero over the past year. Yet the downturn persists. When all else fails (or at least appears to fail), Keynes’s deficit spending presents itself as an option.
Keynes, then, is like the foul-weather friend of economists, appearing only when times are tough. Dr. Paul Davidson, the author of John Maynard Keynes, noted that in this sense today’s Keynesian stimulus plan was utterly predictable: “When things get bad then suddenly people realize that Keynes had something to say.”
Keynes’s ideas, however, lose their luster when the economy is not in crisis. Keynes began to fall out of favor in the '70s, when neo-Keynesians like Paul Samuelson, Robert Solow, and James Tobin—all Nobel recipients—began to think that Keynes’s policies could not only ward off future recessions, but also keep the economy at full employment. They failed to appreciate Keynes’s distinction between voluntary and involuntary employment, and embarked on the quixotic goal of eliminating all unemployment. “What was called Keynesian economics, developed by Paul Samuelson and others, had nothing to do with what Keynes said,” Davidson argued. “Samuelson got it all wrong, he assumed there was a trade-off between employment and inflation.… Keynes doesn’t say that at all.”
Samuelson’s mistaken belief, which became Federal Reserve policy, was that, even in strong economies, expanding the money supply would decrease unemployment. This policy inevitably led to too much money chasing too few goods, and caused inflation. Samuelson neglected Keynes’s dictum, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” Indeed, after about 20 years of the neo-Keynesians’ attempts at fine-tuning the economy, Americans were tired of inflation rates as high as 14 percent in 1980 and the attending malaise. By the election of 1980, Americans were thoroughly sick of Samuelson’s Keynes and ready for Friedman.
Even Obama’s economic team somewhat reflects this shift from Keynes to Friedman. Austan Goolsbee, an advisor, taught at the University of Chicago, Friedman’s intellectual sacristy. Goolsbee even eulogized Friedman in the New York Times after his 2006 death—as did Summers. Jason Furman, a member of the Council of Economic Advisors, draws criticism from the left for his conservative defenses of Wal-Mart and free trade.
The fact remains, though, that, along with other centrist officials like Christina Romer and Timothy Geithner, these economists are unabashedly Keynesian, as evidenced by their stimulus plan. Furman’s declaration in a 2008 Los Angeles Times article that the Keynesian view of stimulus is “standard textbook economics” displays a paradoxical combination of Friedman’s libertarianism and Keynes’s activist government philosophy. For Obama’s administration, Keynes is not a progressive savior but merely a technical contributor to the mainstream understanding of recessions.
DOES THEIR KEYNESIANISM MEAN that this cadre of economists will repeat the mistakes the neo-Keynesians made in the “Great Inflation” years? Perhaps they too underestimate the threat of inflation. The stimulus bill is slated to cost over $1 trillion, including interest, and the president has promised deficits of over $1 trillion for the next few years. Add to that the current $10.9 trillion national debt, and then consider that there are over $50 trillion of unfunded liabilities in entitlements about to start coming due when the Baby Boomers retire.
Meanwhile, the Fed’s balance sheet has more than doubled in the past year, to nearly $2 trillion. While this expansion of the money supply boosts lending and counters deflation in the short term, it will be one more inflationary factor for the government to address when the economy recovers. Surely Obama’s team is aware of these threats, and probably in the same textbook it found Keynes’s stimulus there is a policy measure supposed to preempt inflation once recession is defeated.
On the other hand, Keynes himself might caution them with his maxim that the future isn’t risky so much as uncertain. No matter how sensitive to the risk of inflation the Obama team’s model is, they cannot be certain based on past experiences that their countermeasures will tamp down monetary expansion’s pernicious effects.
About the Author
Joseph Lawler, former managing editor of The American Spectator, is editor of Real Clear Policy. Follow him on twitter: @josephlawler.
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Pingback| 4.16.09 @ 6:53AM
Interest Rates » The American Spectator : We're All Keynesians Again links to this page. Here’s an excerpt:
Old Soldier| 4.16.09 @ 7:27AM
It's never worked, ever.
Indiana Alex| 4.16.09 @ 8:14AM
I guess the next failed set of economists will be called Krugmanians.
Truth Hurts| 4.16.09 @ 12:02PM
Economists teach (and Obama yesterday discussed) what they call "the paradox of thrift."
Essentially, when the economy cools, people save. Acting in rational self-interest, they make decisions that protect themselves in the short run but that endanger the overall health of the economy. People stop spending, so that means more layoffs, less consuming, less production.
In response to this, the government SPENDS. This, in Keynes's view, circulates the economies "animal spirits."
Republicans do it, Democrats do it. It is orthodox economic practice, and it works.
All of this buffoonery and all of these charges of socialism are just so much hogwash.
SLG| 4.16.09 @ 12:09PM
Cristine Romer and Tim Geithner are "centerists"? GadZooks!
pugsley| 4.16.09 @ 1:23PM
To quote Miss Daisy, 'I think I am going to spit up'.
fundamentalist| 4.16.09 @ 1:37PM
TruthHurts, There is no historical evidence that it works. In fact, the historical evidence is overwhelmingly against Keynes. The 19th century and the early 20th century contain a dozen depressions. The economy recovered rapidly from each one with no state intervention. This proves that forces within the economy have the power to reverse depressions. These include increased savings and falling prices.
The first attempt by the state to stop a depression came in 1929 and ended with the longest, deepest depression in world history. So we can be forgiven for being a little skeptical of state intervention. When applying stimuli from the state, it's impossible to separate out the effects of the stimuli and the natural ability of free markets to recover from depressions. However, the depressions from 1929 until today have generally lasted longer and gone deeper with state intervention than depressions before without state intervention.
When the US begins to recover from the current depression, socialists will claim victory, but they would be wrong. They assume their socialist schemes provided the recovery, but the willingly ignore the recuperative power of free markets.
Michele San Pietro| 4.16.09 @ 3:34PM
I am not a Keynesian and I will never be one!
ACynic| 4.18.09 @ 11:46AM
Excessive credit (leverage) fueled by cheap money invariably leads to a mis-allocation of resources , and a bursting bubble, followed by a recession or worse, a depression.
Until asset prices decrease - to a level where demand and supply equilibrate - demand will be minimal.
The error of the FDR and the FED in the 30s, in addition to allowing money supply to shrink, was their effort to maintain artificially inflated asset values; which, given the massive unemployment, caused a lack of demand and deflation.
Of course, demand initially dried up - causing massive unemployment - due to lack of credit (money), and the total shutdown of US exports due to the stupidity of Hoover/FDR/Congress; the infamous Smoot Hawley Tariff which, literally, precipitated the shut down of world trade.
WWII got the US out of the depression because TO MEET THE DEMAND - for war materiel, millions had to be hired and millions had to be drafted (removing them from the unemployment rolls.)
It is important to realize that the DEMAND for goods due to WWII , CAUSED massive hiring; it was not the massive hiring that caused the demand.
Krugman insists that WWII "proved" that pump priming can deliver a country from a recession. He has it exactly backwards. Again, it was the DEMAND for goods that preceded the hiring and reinvigoration of the economy.
Of course, not to mention that WWII forced FDR to remove his job killing, economic growth killing burdensome rules and regulations if he expected the American economy to meet the demands of war.
Saving and investment are the path to real economic growth. Keynesians insist that this is a "paradox" because if folks save and invest, it restricts demand.
Again, this is exactly backwards.
The money HAS to go somewhere !!!
Eventually, it will (it must) wind up in a bank or back in the economy somehow, unless it literally is kep in a mattress; it eventually where it must be lent or the banks will go under. Further, if folks feel confident in their "nest eggs," they will eventually spend, little by little, increasing demand and employment.
You cannot force folks to spend and thus goose demand. The govt. merely can provide temporary "jobs," but even then, it is only to a very small subset of all workers - mainly construction workers.
If "pump priming" actually worked - and it NEVER has - California today would be drowing in money. California has been pump priming for 8 years - via copius use of the credit card. According to the Keynesians, they should be suffering from full employment, too much wealth and the inablility to figure out what to do with the trillions and trillions of dollars in the state govt. vaults.
Of course, they are bankrupt.
So much for Keynesian pump priming.
The lesson of Japan is here very useful. Despite near zero interest rates, the Japanese have a pathetic domestic consumer demand and refuse to spend; even though the Japanese govt. has literally spent trillions of yen on public works projects over the last 15 years.
Why do the Japanese refuse to spend ??
My guess is that some of this is cultural but that most of it is due to the expense of buying anything in Japan - from jeans, food, cars , housing, books, gasoline, medical care (which stinks there, by the way), etc. etc., on top of which their taxes are rather onerous. So, you buy only what you really need , and nothing more.That is, the govt. can make things so expensive they literally can shut down domestic consumption.
Recently, the German govt. announced rebates if citizens purchased a new car in an effort to energize their moribund car sales. As soon as they did this, car sales took off. Prior to this, new car sales in Germany were not very good - even in good times - because cars and fuel and insurance and fees and taxes are TOO DAMN HIGH !!
Again, saving and investment are the key to economic growth and job creation; there is no paradox except in the fictional econometric models of the cargo-cult "science" of economics.
Demand can literally be shut down - and thus have higher unemployment - if govt. imposes enough onerous rules, taxes, fees, regulations, etc. to deter folks from buying much of anything.
Just look to last year when gasoline hit $4 / gallon; it is no coincidence that the onset of our present recession began at that time.
Very high energy prices translate into higher prices for food , clothing, heating, travel, electricity, everything.
It literally shuts down the economy.
Prior to the founding of the Federal Reserve in 1913, the US was able to evict itself from all the panics (recessions/depression) with little or no govt. intervention.
The economic history subsequent to 1913 does not reflect too well on the success of the Federal Reserve; more often they have made things worse. Of course, our inept politicians also have - for the most part - screwed things up royally.
Our next deep recession is around the corner with the institution of "cap and trade," which, like $4 /gallon gasoline will literally shut down the economy.
Obama - the millionaire, and his uber-rich liberal demokrat millionaire pals - will be immune to the economic hardships they will cause. Like most politicians, they could give a rat's ass if they screw the folks as long as their policies they enact make them feel superior/better/smarter. Just as FDR screwed over the average American from pre-WWII (33-41), he did not care because he too was a millionaire and was insulated from the suffering he foisted on the average American.
Idealogy trumps everything.
Today the FED has learned from the Great Depression that a shrinking money supply will create deflation and a bad recession (or depression). So they are printing money like crazy.
This will end very badly.
The FED , upon the first whiff of recovery or inflation will attempt to "slow down" the economy by raising short term rates (the only rates they truly can affect), which will depress economic activity.
The Congress will not permit this and pressure the FED to maintain low interest rates and ample money supply.
This movie has been seen many times before and it always end badly.
Keynesian economics ranks right up there with astrology; the lessons of Weimar and Argentina mean nothing to them.
Monetarists have turned into a science the common sense notion that if credit is not available - for whatever reason (say, lack of money) then business will contract.
Keynesians insist that savings and investment lead to recession /depression ; a notion that defies all common sense.
Keynesians insist that you can spend your way - via the credit card - into prosperity , despite the historical evidence of the contrary.
Politicians love economics because it gives them the intellectual excuse to be able to screw up and destroy the lives of ordinary folks and, thus, amass more power.
Claire Solt| 4.19.09 @ 1:46AM
I see a lot of careless malinvestment. We propper up five too big to fail banks and would surely have been better off to spread our depoisit amont the 8,000 which did not gpogre on bad investments. Likewise we will invest a lot in wind and solar that is not economic instead of holding out for the breakthrough that will be.
Trackback| 4.20.09 @ 9:40AM
Atlanta news, on Atlanta news, links to this page. Here’s an excerpt:
swer| 4.22.10 @ 12:04AM
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Getting Hercules to Help You
Hercules won’t help you until you have all five items from Zeus’ quest. Once you have the five items, bring them to Athena. Zeus will appear and steal them. The big jerk! Once this happens, talk to Athena and she will tell you that Hercules will help you.ArenaBetting.com dukung fair play FIFA world cup AFSEL 2010 You’ll need to have the magic mirror from Aphrodite because Hercules doesn’t want to have to walk. He’s so lazy!
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You can see how to do this in the videos, but basically you need to jump up when the Hydra is about to strike. He will rear one of his heads back to attack and his eyes will bulge out. When this happens, jump up in the air and then try to land on top of his head. That head will get knocked out. When all five heads get knocked out, the Hydra will be asleep and you can click on him to get one of the scales.Poptropica