The Keynesian Dead End
Spending our way to prosperity is going out of style.
Today's G-20 meeting has been advertised as a showdown between the U.S. and Europe over more spending "stimulus," and so it is. But the larger story is the end of the neo-Keynesian economic moment, and perhaps the start of a healthier policy turn.
For going on three years, the developed world's economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity. It hasn't turned out that way.
Now the political and fiscal bills are coming due even as the U.S. and European economies are merely muddling along. The Europeans have had enough and want to swear off the sauce, while the Obama Administration wants to keep running a bar tab. So this would seem to be a good time to examine recent policy history and assess the results.
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Like many bad ideas, the current Keynesian revival began under George W. Bush. Larry Summers, then a private economist, told Congress that a "timely, targeted and temporary" spending program of $150 billion was urgently needed to boost consumer "demand." Democrats who had retaken Congress adopted the idea?they love an excuse to spend?and the politically tapped-out Mr. Bush went along with $168 billion in spending and one-time tax rebates.
The cash did produce a statistical blip in GDP growth in mid-2008, but it didn't stop the financial panic and second phase of recession. So enter Stimulus II, with Mr. Summers again leading the intellectual charge, this time as President Obama's adviser and this time suggesting upwards of $500 billion. When Congress was done two months later, in February 2009, the amount was $862 billion. A pair of White House economists famously promised that this spending would keep the unemployment rate below 8%.
Seventeen months later, and despite historically easy monetary policy for that entire period, the jobless rate is still 9.7%. Yesterday, the Bureau of Economic Analysis once again reduced the GDP estimate for first quarter growth, this time to 2.7%, while economic indicators in the second quarter have been mediocre. As the nearby table shows, this is a far cry from the snappy recovery that typically follows a steep recession, most recently in 1983-84 after the Reagan tax cuts.
The response at the White House and among Congressional leaders has been . . . Stimulus III. While talking about the need for "fiscal discipline" some time in the future, President Obama wants more spending today to again boost "demand." Thirty months after Mr. Summers won his first victory, we are back at the same policy stand.
The difference this time is that the Keynesian political consensus is cracking up. In Europe, the bond vigilantes have pulled the credit cards of Greece, Portugal and Spain, with Britain and Italy in their sights. Policy makers are now making a 180-degree turn from their own stimulus blowouts to cut spending and raise taxes. The austerity budget offered this month by the new British government is typical of Europe's new consensus.
To put it another way, Germany's Angela Merkel has won the bet she made in early 2009 by keeping her country's stimulus far more modest. We suspect Mr. Obama will find a political stonewall this weekend in Toronto when he pleads with his fellow leaders to join him again for a spending spree.
Meanwhile, in Congress, even many Democrats are revolting against Stimulus III. The original White House package of jobless benefits and aid to the states had to be watered down several times, and the latest version failed again in the Senate late this week. (See below.) Mr. Obama is having his credit card pulled too?not by the bond markets, but by a voting public that sees the troubles in Europe and is telling pollsters that it doesn't want a Grecian bath.
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The larger lesson here is about policy. The original sin?and it was nearly global?was to revive the Keynesian economic model that had last cracked up in the 1970s, while forgetting the lessons of the long prosperity from 1982 through 2007. The Reagan and Clinton-Gingrich booms were fostered by a policy environment for most of that era of lower taxes, spending restraint and sound money. The spending restraint began to end in the late 1990s, sound money vanished earlier this decade, and now Democrats are promising a series of enormous tax increases.
Notice that we aren't saying that spending restraint alone is a miracle economic cure. The spending cuts now in fashion in Europe are essential, but cuts by themselves won't balance annual deficits reaching 10% of GDP. That requires new revenues from faster growth, and there's a danger that the tax increases now sweeping Europe will dampen growth further.
President Obama's tragic mistake was to blow out the U.S. federal balance sheet on spending that has produced little bang for the buck. The fantastical Keynesian notion (the "multiplier") that $1 of spending produces $1.50 in growth was long ago demolished by Harvard's Robert Barro, among others. That $1 in spending has to come from somewhere, which means in taxes or borrowing from productive parts of the private economy. Given that so much of the U.S. stimulus went for transfer payments such as Medicaid and unemployment insurance, the "multiplier" has almost certainly been negative.
With the economy in recession in 2008 and 2009, we argued that some stimulus was justified and an increase in the deficit was understandable and inevitable. However, we also argued that permanent tax cuts aimed at marginal individual and corporate tax rates would have done far more to revive animal spirits, and in our view would have led to a far more robust recovery.
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What the world has now reached instead is a Keynesian dead end. We are told to let Congress continue to spend and borrow until the precise moment when Mr. Summers and Mark Zandi and the other architects of our current policy say it is time to raise taxes to reduce the huge deficits and debt that their spending has produced. Meanwhile, individuals and businesses are supposed to be unaffected by the prospect of future tax increases, higher interest rates, and more government control over nearly every area of the economy. Even the CEOs of the Business Roundtable now see the damage this is doing.
A better economic policy will have to await a new Congress, which we hope at a minimum can prevent punishing tax increases. But for now the good news is that voters and markets are telling politicians to stop doing what hasn't worked.
http://online.wsj.com/article/SB10001424052748703615104575328981319857618.html
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In the Long Run, Keynesian Economics is Dead
June 29th, 2010 · No Comments
The teachings of
John Maynard Keynes, the darling of the tax and spend left, are fast becoming passe in Britain reports
Matthew Lynn of Bloomberg.com (emphasis mine):
The U.K. has produced notable economists over the years, but John Maynard Keynes, the guru of government intervention, was one of truly global significance.
So it may be fitting that the U.K. will also become the deathbed of Keynesian economics.
Britain has been following the mainstream prescriptions of his followers more than any developed nation. It has cut interest rates, pumped up government spending, printed money like crazy, and nationalized almost half the banking industry.
Short of digging Karl Marx out of his London grave, and putting him in charge, it is hard to see how the state could get more involved in the economy.
The results will be dire. The economy is flat on its back, unemployment is rising, the pound is sinking, and the bond markets are bracketing the country with Greece and Portugal in the category marked “bankruptcy imminent.” At some point soon, even the most loyal disciples of Keynes will have to admit defeat, and accept that a radical change of direction is needed.
Lynn says that recent dispute between economists has brought the issue to the forefront (emphasis mine):
On Feb. 14, a group that included the former Bank of England policy makers Tim Besley, Howard Davies, Charles Goodhart and John Vickers published a letter to the Sunday Times calling on the government of Prime Minister Gordon Brown to control the ballooning deficit. If it didn’t, the stability of the economic recovery would be threatened, and there would be a run on the pound, they warned.
That brought a stinging response from the Keynesians, who are urging the U.K. to spend its way out of recession. Nobel laureates Joseph Stiglitz and Robert Solow were among the signatories to letters written by a group of 67 [Keynesian] economists insisting that deficit spending was the only way to salvage the economy.
And here’s the Telegraph’s
Jeremy Warner skewering Obama’s economic homunculus,
Paul Krugman:
Mr Obama’s cheerleader-in-chief in arguing the case for continued international deficit spending is the American economist Paul Krugman.
This hyperactive Nobel prize winner has achieved almost celebrity status for his extreme neo-Keynesian views. Yet his frequent polemics on the supposed merits of “let rip” public spending long since ceased to be based on objective analysis, and are instead argued as a matter of almost ideological conviction.
He’s as much a fundamentalist as the “deficit hawks” he mocks.
But it’s not only the Brits who are seeing the light. From
Jim Hoft of Gateway-Pundit, here’s what German Chancellor
Angela Merkel said last Friday at the G-20 summit in Toronto:
We need growth that doesn’t rely on debt but is based on real grounds. The world needs a new architecture for the financial markets and me and the EU will advertise for that very intensively.
Now more than ever, with the world on the brink of financial collapse, it’s necessary for leaders like President Obama to escape their comfort zones and embrace ideas that they would not have embraced in cushier times.
That takes guts. Let’s see who has them.
http://blog.pappastax.com/index.php/2010/06/29/in-the-long-run-keynesian-economics-is-dead/
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The Long-Deserved Death Of Keynesian Economics
by
Dave Price on August 9, 2010
in
Politics
Tim Cavanaugh has
a devastating cite from just-retired Obama economic adviser Christina Romer:
The generally precise Romer spells out the difference for us: Using this approach, the estimated multiplier for monetary policy is 0.823 and the estimated multiplier for fiscal policy is -0.233.
You don’t say. Gee, that would have been nice to know a few trillion dollars ago.
Democrat Party water-carriers like Paul Krugman love Keynesian economics, with its assumed large fiscal multiplier, because it meshes so perfectly with leftism’s general preferences: more government, bigger government, more public-sector employees, higher pay for those employees — and, naturally, higher taxes to go with all that. Their continued insistence we need to spend (
and tax!) more, more, more even as unemployment goes higher and deficits mushroomm is growing ever less credible with
each additional “unexpected” signal of economic failure.
If there’s one positive to come out of the Great Recession, it should be the end of Keynesian economics as a serious policy choice. The notion you can grow the economy via North Korea-style command economics should have been long-dead even before Romer’s 1992 paper, but Obama’s miserable failure may finally drive a stake through this productivity-sucking, economy-killing meme.
Let me put this simply — and contradict a too-widely-held assumption of macroeconomics:
THERE IS NO SUCH THING AS AGGREGATE DEMAND.
Government spending is not demand, it is
command spending. To “aggregate” it with private sector demand is like counting your dog’s ringworm as a “pet” on a census form, at least for purposes of stimulating the economy. It does not follow the same rules as private sector spending, as it is always seized and distributed according to law/fiat by bureaucrats indifferent to costs and benefits, not exchanged consensually between self-interested private parties seeking to maximize their utility. That’s why Keynesianism is “unexpectedly” falling flat on its face before our eyes: it relies on a
fallacious aggregation.
(Now, generally about this time someone on the left perks up and says “But… roads!” Yes, we need roads (but tend to also get Bridges To Nowhere), just as we need regulation, laws, etc. My point is not that all government spending is wasteful, just that government is 1) not very good at allocating resources to what is actually useful versus wasteful/cronyist/populist, and 2) is spending far more than it should, esp. given #1. Optimal government spending levels (i.e. those associated with highest levels of economic growth) appear to be something between 20% and 30% of GDP, whereas in the U.S. those levels
are now exceeding 40%.)
http://deanesmay.com/2010/08/09/the-long-deserved-death-of-keynesian-economics/
