Is Keynesian Economics Dead?
Robert Samuelson asks that question — and gives his answer — in this morning’s Washington Post:
Governments have ceded power to bond markets by decades of shortsighted behavior. The political bias is to favor short-term stimulus (by lowering taxes and raising spending), which is popular, and to ignore long-term deficits (by cutting spending and raising taxes), which is unpopular. Debt has risen to hazardous levels, undermining Keynesian economics as taught in standard texts.
Were Keynes alive now, he would almost certainly acknowledge the limits of Keynesian policies. High debt complicates the analysis and subverts the solutions. What might have worked in the 1930s offers no panacea today.
The problem with the austerity solution is that when governments slash spending, they also decrease government revenues — and deficits continue to balloon. Austerity has not improved Greece’s financial situation; just as it did nothing to cure Japan’s decades long slump. It’s an old story. By focusing on the forest, policy makers don’t see the trees. Austerity does not create growth.
It’s true that bond markets possess more power than they warrant. One needs only to recall that Moody’s, Standard and Poor’s and Fitch’s rated those sliced and diced mortgages — which so enriched Wall Street — as gold plated investment opportunities. The real question policy makers should ask is, “Why do the bond raters still have any credibility?” Instead, we kneel before them, humbly seeking their approval.
Debt is a problem. But austerity now makes the problem worse.
22 Responses to “Is Keynesian Economics Dead?”
Samuelson is possibly the most ignorant columnist writing on economics today.
Cutting spending slashes revenues? Revenue is not directly tied to spending. One can cut spending and continue taxing, which is what should be done.
Start with the defense budget please. By about 75%, and if you truly want to reduce the cost of government, then eliminate the fifty states and create four or five provinces. That is where the cost of government is being wasted. On fifty unnecessary governments.
Like it or not, the ‘real’ government spending is not what the politicians try to portray. Is it government spending if someone buys groceries? “Well…that depends,” suggest the neocons and conservatives. On what would it depend? Whether or not the person received that money from the government. In a fascinating turn of events, it seems that they don’t even care why the person received that money–unless it was for contract work. In their economic fantasy world all government employees are leaches (along with people who are dependent on the government due to disability or age).
Why would cutting spending lower revenues? Because the spending that is most likely to be cut is that which either employs lower-wage earners or that which goes to them directly (i.e. social programs to help the poor and destitute). These people spend the majority (or entirety more likely) of the money that they get–thus getting the full impact of their income to spur the economy.
The very wealthy have a much lower % of spending. They invest–even if the return on investment is minimal. A tax break for wealthy people gives much less back (as bang for the buck) to the economy because they don’t tend to spend money. What?? Am I crazy??? No, they don’t spend money, they spend plastic. They don’t tend to ask themselves if they have enough money to buy everyday things, they know that they do. Their financial managers pay for everything and simply tell them if they are meeting goals and such.
As for the claim of, “fifty unnecessary governments,”: what about county governments and city/town governments? Maybe we should eliminate all the governments except for one king of our country? Hmm…I think we tried to deal with that about 250 years ago?
It is very possible that one of our problems is having too FEW state governments (thus larger states have huge influence–leading to silly things like early caucuses and early voting in primaries by states to try to gain some small influence). In addition, the more people we get, the same number of representatives we have. What??? Doesn’t that make our representatives LESS responsive to individual voters? Yes, of course it does.
Meanwhile, the influence of corporations has been warned about since Jackson and Van Buren http://www.washingtonsblog.com/2010/09/government-using-anti-terrorism-laws-to-crush-dissent.html
But don’t expect the quotes from the above link to sway any politicians currently running for offices that can actually change anything.
Owen: “The problem with the austerity solution is that when governments slash spending, they also decrease government revenues…”
But Samuelson’s argument suggests is that this is not necessarily true, so this is not so much a counter-point as it is a contradiction.
I don’t know how close to the edge we are, but that’s part of Samuelson’s concern: we don’t know and won’t know until it’s too late. The argument from those who want more stimulus is that interest rates are low indicating that the markets can absorb more government debt. The problem, as Samuelson implies, is that interest rates can change quickly but our debt cannot. If investors decide tomorrow that the US might not be able to finance its debt, rates will rise, further adding to our deficits and starting a vicious cycle. And Samuelson doesn’t mention that default is not the only danger: rising interest rates would make it more difficult for private borrowers which would slow down the economy regardless of whether default was really imminent.
I acknowledge, adelinesdad, that there really is a such a creature as a “debtwall,” where debt becomes unsustainable.
So we really need a long term plan to control spending. People forget though that, while Keynes was in favor of priming the pump, he also was in favor of balancing budgets in the good times.
We’ve gotten into trouble because we have increased spending and slashed taxes in the good times. In fact, there is a particular segment of our political class who believes in that policy regardless of the times.
Keynes believed in reducing debt — but not during a recession/depression. What has changed is the influence of the rating agencies — an influence which is clearly undeserved.
Owen,
I agree although I don’t know much about the rating agencies beyond what I hear in the news.
Contrary to how Krugman and others are twisting his words, Samuelson is not saying that Keynes was wrong (he says he supported the first stimulus and would again under the same conditions), just that the principle only works within certain parameters. He supposes that Keynes would acknowledge that, and I think he would too because any reasonable person would have to. Samuelson’s argument is that we may have exceeded those parameters and are now too close to the edge where a Keynesian policy would be too risky. I don’t know if that’s true, but that’s a different argument than whether Keynes was correct.
As for deficits in good times, yes that is the major problem, along with the exponential growth in healthcare costs. As far as I understand it, Keynesian economics is sound in principle but, as with any economic principle, it relies on the discipline of politicians (and, by extension, the voters). But that is also tangential to Samuelson’s argument regarding whether Keynesian policies will work now.
adeleinesdad,
I think your reading of Samuelson is correct. My argument with the ratings agencies is that they’ve stoked a lot of fear, just as they stoked “irrational exuberance.”
My hunch — given the level of debt which the United States faced after World War II — is that the fear they have generated is not commensurate with that level of debt.
Cooler heads should prevail.
@Owen Gray
World War II debt differed in one vital aspect: the war was over. Whereas we could make radical cutbacks with relative ease, no such option is realistically available today, as several budget battles have proven.
As to the title of this piece: obviously real Keynesian-ism died long ago, as Keynes advocated paying off debt (not balancing the budget) during times of growth. While some states have created “rainy day” funds that would reflect Keynes philosophy, the federal government doesn’t seem capable of cutting back, regardless of the state of the economy.
One thing Reagan did was force civil service defense workers into mandatory overtime for months on end. The more you make, (time and a half and double time), the more tax is taken. At some point you’re not bringing home that much. Especially after Reagan raised taxes. The gov got more back in tax with the more overtime you were forced to work. The gov made out like a fat rat in a cheese factory even though the workers just sat around, having done all the work already. Amazing waste, but that’s how Republicans think. They’ll spend a dollar to save a dime if they’re doing the deciding.
Incredibly Reagan was letting uniformed Soviet military officers examine our brand new B1 Bomber inside and out, during the late 80’s, right here in the U.S. at Tinker Air Force Base. I saw this with my own eyes and it’s a matter of local news public record in OKC. Senator B1 Bob Dornan, (and conservative talk radio host), Did not complain one iota at Reagan, but dogged Bill Clinton every time he could for far lesser transgressions. Such is the hypocrisy of the Republican Party.
Prof,
The war ended but the spending didn’t. There was the G.I. Bill, the Marshall Plan, the Korean War, the Interstate Highway System and the Space Program.
With the exception of Korea, the government wracked up a lot of invested debt — in human capital and infrastructure. The debt to GDP ratio went down and the economy grew, until LBJ refused to pay for the Vietnam War.
That refusal — and the Arab Oil Embargo — had a lot to do with the stagflation of the ’70s.
Reagan cut taxes and increased spending until George Bush the Elder followed Keynes’ advice and raised taxes. It cost him his re-election. But he handed Bill Clinton an economy which was just beginning to grow. And even Reagan eventually raised social security taxes. “Facts,” he said, were “stubborn things.”
When Clinton raised taxes, Republicans howled that there would be economic Armageddon and . . . well, you know the rest of the story.
Following Keynes’ advice has brought the nation’s finances into balance — and surplus — more than once.
Allen, yes that’s the definition of partisanship, as far as I’m concerned. Yes it is hypocrisy to the extent that partisanship implies. But partisanship is a pretty universal problem in politics, so I’m not sure what that has to do with this discussion.
Owen, in my opinion the thing that makes now different than in the past is the future projection. I don’t think there has every been another time where our projected debt seemed so unmanageable, politically and practically. We could probably be OK with >100% debt/gdp ratio as long as there was a path to get it back down. But, if we’re in that territory and thing only look to get much worse, investors are more likely to get nervous. Looking at the projections for entitlement spending makes me very skeptical that we will be back to paying down the debt anytime soon, good times or not.
I understand your skepticism, A.D. The present back and forth between the House and Senate is yet another example of government’s inability to get anything done.
That problem, though, is solvable — if voters truly want to do something about it.
Wow, I love this site, an intelligent discussion about the economy, and about Keynes. The term Keynesian economics has become a pejorative that means ‘all of the economic policies I don’t like’ to so many without any understanding of what it really means.
What should be dead now is supply side economics, Reaganomics, whatever you call the political economics that has brought us to this point of recession and debt deflation. And what also should be dead is a big part of neo-classical economics, the current academic economics of choice, think Ben Bernanke, which failed to make much headway against the recession using their weapon of choice, monetary policy.
Unfortunately neither seems to have taken much of a hit. Supply side economics is still the policy of choice of one major party. In fact they are promising to double down on it. More tax cuts for the wealthy, more policies to suppress the wages of the non-wealthy. One can only believe that these policies are popular with this party because of the policies themselves, in spite of their consequences for the economy. Truly they seem to believe that the means justifies the end.
It is not even very encouraging to look at the other major party, the one nominally in power. They seem to have bought in to supply side economics, or at the very least, they seem unwilling to do the work needed to point out supply side economics now all too obvious flaws.
And academic economics seems to be doing what comes easily to them, coming up with multiple theories that allow them to ignore the failure of monetary policy to relieve the recession.
@Owen: “The war ended but the spending didn’t.”
Your facts, sir:
Time Series Chart of US Government Spending
US Federal Deficits in the 20th Century
@Merkin
Supply-side economics is a version of pseudo-Keynesian economics. It simply emphasized stimulus through tax reduction instead of spending.
I take your point, Prof, that deficits decreased after the war. But surely that had something to do with tax rates.
From 1946 until 1954, the lowest tax bracket ($10,000+) varied from 38% to 43%. The highest bracket varied from 89% to 91%. Spending increased, but Americans paid a higher percentage of their income to cover that spending.
The chart you reference shows that when Reagan cut the lowest rate to 18% and the highest rate to 70%, deficits began to rise. As of 2011, the lowest tax rate ($10,000+) is now 10%; and the highest rate ($379, 000) is 35%.
There is a direct correlation correlation between deficits and tax rates. The drop in the deficit after the war had a lot to do with to do with taxes.
@Owen
Apparently you didn’t look at the other graph: spending, which after the war also suddenly dropped back down to close to pre-war spending.
Yes, of course there’s a relation between deficits and taxes, but spending is the other half. Also, the top bracket is a really poor, often deceptive, indicator of overall effective tax rates, because it can apply to only a few people, and can often simply push those few to simply restructure their income. Another point that makes historical comparison difficult are payroll taxes, which effectively go into the same pot, but are often shown separate from income tax. If you wanted to honestly compare tax revenues, it should be total government revenue vs total income earned by the taxpayer (which is surprisingly rare).
In any case, my original point was that post-WW II spending can’t be compared to current spending because we had the option of dropping it back quite suddenly (as the spending graph shows), which isn’t a viable option today.
The Wars in Afghaistan and Iraq contributed mightily to the deficit, Prof. As American troops leave those countries, that spending — as at the end of World War II — can be drawn down rapidly.
But pressure is going to be applied to entitlements — to social spending. My point is that spending on social programs increased after World War II; and tax rates supported that spending. It also supported economic activity. Simply put, it spurred economic growth.
Oh, there’s room to shrink in the military budget alright, but not $1.6 trillion. Even if we cut $600 billion from defense spending (FY2010 budget was only $680 billion), do you honestly think that we can raise an extra trillion in taxes without affecting the economy? And of course, the projected deficits (which are usually optimistic, often highly so), are even worse.
While the economic growth is well-documented, the source isn’t, and the point is tangential to the one I’m making.
I don’t mean to suggest that decreasing military spending will balance the nation’s books, Prof. To accomplish that, taxes will eventually have to be raised.
A little more than a decade ago, your country was running a surplus. A little more than six years ago, my country was also running a surplus.
The Harper government — taking its cue from the Bush administration — reduced taxes as soon as it arrived in Ottawa. With in 18 months a $12 billion surplus had disappeared. When the recession hit, we quickly ran up the largest deficit in Canadian history.
We are in this spot because our elected representatives have purposely put us here.
@Owen
They put us in this spot because it feels good, and the central banks can keep interest rates low enough to allow massive borrowing, especially after Nixon gave up even the pretense of a metals-backed currency — but not without consequence. The pseudo-Keynesians were in paradise: unprecedented room to stimulate the economy to whatever heights that they wanted in good times and bad. But the consequence of a long run of artificially low interest rates is huge malinvestment and massive instability. The actors and props vary by country, but the stories all follow the same plot.
Think about it, if three people on an island were given 100 coins each, how could they all get into debt at the same time? It’s not physically possible. Even the foreign debt doesn’t account for the total public/corporate/personal indebtedness that we’re in right now. That’s why the most massive monetary pushes ever attempted aren’t working.
You can rail against supply-side economics all you want, but the new debt is coming from the Fed. That Fed money goes to the banks, who use it to buy government bonds, so that taxpayers are paying for the bank profits. It doesn’t matter where you spend that debt money, the bankers already profited from it. Which, I believe, would count as supply-side economics.
Chart of US Top 1% Income Share (1913-2008)
Tax rates by income group
Note how top tax rates dropped in the late 70s, with little effect on the income of the 1% until the late 80s. However it does correspond quite nicely with this chart:
Gross Federal debt, at least after WW II, which was the last time that all citizens, both rich and poor, were dedicated to a single cause.
Owen, at the risk of repeating myself I just want to point out again that our problem is the projected debt more than it is our current debt.
Yes, tax cuts and wars play a significant role in the debt that has been accrued in the past decade. As a leaning-conservative I like low spending/taxes. But I also believe that we should pay for what we buy, so I’m in agreement with you that we should not have slashed taxes if we weren’t prepared to do the same to spending.
But even if we were to somehow undo that, the projected deficits that will result from increases in health care costs dwarf those factors. Revenue would have to be higher, as a percentage of GDP, than it has ever been before, including during/after WWII, to keep up with that spending growth.
And back to the original post, given all of this it’s not clear that adding more to the debt now in the name of stimulus is a good thing, even short-term, if it adds to the legitimate fiscal concerns about our future. Those concerns are not diminished by saying that we can raise taxes later to account for the extra spending, because those extra taxes, even if they are implemented, are already more than accounted for.
A.D.
I acknowledge that the future looks frightening, given the numbers that we’re looking at. But there are a couple of things Keynes stood for which, I think, are still true:
1. Don’t slash spending in the middle of a recession. It only adds to the deficit.
2. There is a time to raise taxes to pay down debt. Now is not that time. But it’s coming.
I would add that current tax rates give the wealthy undeserved and unfair leverage.
As for fixing the problem, we are faced with the old dilemma: Everyone wants to go to heaven; but nobody wants to die.