You Are Not The Keynesian You Think You Are

Posted on February 6, 2013
Filed Under Critical Thinking, Economics |

I take a fair number of jabs on Twitter at President Obama’s economic policies because, well, frankly, I think he is terribly misguided. As a result, I’ve had to watch numerous liberals jump to his defense and try to explain Keynesian economics to me. Now, I’m not a professional economist, but I have taken several undergraduate and graduate economics courses, I read about a dozen books on economics each year (even some advanced textbooks) and I attend seminars in the Cambridge/Boston area from time to time about economic issues that interest me. I’ve spent the last two years particularly fascinated by the resurgence in Keynesian economics.

So, I do believe I have a better understanding of economics than most people, even most educated people, and what follows is my explanation of Keynes’ key ideas. I also want to point out that, this isn’t a right/left debate like most people think. Bush was a huge Keynesian, and I believe Obama’s economic ideas are closer to Bush’s than they are to Clinton’s, which is why it seems so philosophically inconsistent to me to hear Clinton fans praising Obama. Clinton’s ideas were closer in alignment to Reagan’s ideas, both of who were influenced by Milton Friendman.

Anyway, I’ll explain my understanding of Keynes, and will wrap up by explaining why I think his ideas are destructive in our current economic climate.

First of all, let me address a key point: modern liberals and modern conservatives are both Keynesians. The primary economic innovation that Keynes brought was this idea that the in the short run, aggregate demand and aggregate supply may not match up, and that aggregate demand is the part of the equation you want to influence. There are two ways to do this. One is to have the government spend more to increase demand. The other is to cut taxes so that individuals have more to spend to increase demand. The former is the Keynesian path preferred by the Democratic party. The latter is the Keynesian path chosen by the Republican party. The point though, is that both are Keynesian.

Secondly, when Keynes advocated increased government spending, he was not referring to the stuff we do today. His logic at the time, when Britain faced high unemployment, was that the government was paying a lot of money to the unemployed, and that it would be better to just hire them and put them to work, instead of paying them to do nothing. Putting people to work would stimulate the economy and give everyone a psychological boost (let’s face it, most people like having a job) and the rest would take care of itself.

What I constantly hear is “hey, don’t we want to spend to make investments to grow the economy and get out of this slump?” But, the Obama administration is not doing that. This administration has decreased the federal workforce and has cut non-defense discretionary spending. In other words, the services the government provides and should provide are the areas being cut. Why? Because politicians are cowards who are more concerned with re-election than anything else, so rather than touch entitlements, the real problem, they nip and tuck here and there and say they are doing something about the problem.

So our problem is that, even if we were trying to be Keynesian, we aren’t. The “investments” we are making are actually very little. We are cutting things we shouldn’t be cutting, and are making the government primarily an entitlement machine mostly concerned with the transfer of wealth. Not all government spending is Keynesian, and based on what I have read about the man, I don’t believe he would have supported a massive entitlement state. Why are we doing this? I don’t know, but if I had to guess, I would give three reasons.

1. Obama believes that by shifting the burden of healthcare to government, he can fix the system. I believe this will turn out the same way it did when the government tried to fix education and tried to fix home ownership… they will make it worse, or have no impact except to waste a bunch of money. I know liberals disagree and believe that smart people working through government can solve big problems. But there are very few examples of government success at this scale, particularly when they meddle in economics.

2. No one will touch social security because old people vote in larger numbers than other people.

3. The Democrats and Republicans both want to prop up the economy artificially, even if it leads to inflation, because that helps the rich and protects their investment portfolios and leads to more campaign donations. Inflation will slam the poor’s standard of living, but they don’t donate big money to campaigns so who cares.

I don’t think Bill Clinton was a Keynesian. Why? Because he passed NAFTA, he cut unemployment benefits and reformed welfare, and he was concerned with balancing the budget because he believe a government deficit sapped money out of the private economy that could be used to fund growth and innovation. Reagan, despite cutting taxes, didn’t do it because he was a Keynesian, he did it because he philosophically opposed government and wanted to minimize government’s impact.

Now, some Republicans will claim that Republicans don’t believe in tax cuts for Keynesian reasons, but rather, because cutting taxes can lead to more revenue. Why do they think that? Because in the past, tax cuts at certain times actually have led to more tax revenue (but most times they haven’t). But, this happened when tax rates were very high, and were significantly slashed, so they actually changed behavior. I don’t honestly believe that most Americans change many of their decisions for a tax increase or decrease of a few percentage points. But when you are taking a massive ax to marginal rates like Reagan did, yeah, that can matter. But the truth is, Bush’s tax cuts were intended to be Keynesian.

I don’t believe what Obama is doing would actually be considered Keynesian by Keynes himself. But that said, I am not a fan of Keynesian stimulus in general. Why? Well first of all, Japan has tried it for two decades and it hasn’t worked.

But even beyond that, it just doesn’t make sense for the current situation. The economy that existed when Keynes proposed his ideas was not the economy we have today. In his day, he was trying to smooth out the business cycle and what he believed were inefficiencies in the free market that occurred because of over investment, or sometimes over saving. I believe that Japan’s boom, and the boom in the U.S., were created by playing with the money supply, and Keynesian economics can’t cure that type of hangover. Let me give you an example. There is a big difference between when your body is naturally tired, so you take some caffeine, and when your body is tired because you have been oscillating between caffeine and some downer drug for months, and you try to take some caffeine. If your body is tired for the first reason, caffeine will have an impact. If your body is tired because you are trying to modify it constantly with all kinds of drugs to control your energy level, the caffeine may have a very different impact. It may even fall flat, or cause more problems. All you can do at that point is suck it up and go through withdrawal.

The U.S. economy is the same way. Keynesian ideas worked back when the economy was otherwise left to its own devices. Then we could go in and guide it a bit. But we started trying to guide it more and more, and now we are trying to use the same medicine to solve our problems that got us into these problems in the first place.

I don’t think there is any way out of this mess except a few painful years of austerity to get back on track, or at least feigned long term austerity by major entitlement reform that may provide some confidence to the economy. My guess is that our politicians don’t have the guts to do that, so they will continue trying to stimulate the economy for another decade, we will see many false starts where we believe it is working, only to be disappointed again, and then finally, a new generation of leaders will take us in a new direction.

To end, I want to point out something very very important. Economic ideas are actually very difficult to test in a controlled environment, so we have to rely on real data which is messy and has a zillion variables influencing it, some of which we may not understand yet. I believe that the economic ideas en vogue at any given moment have more to do with which economists are popular, not the validity or accuracy of their ideas. In the 80s and early 90s, Milton Friendman was king. He was witty, smart, and usually won debates with his great aphorisms. (My favorite may be “if you put the federal government in charge of the Sahara desert, in 5 years there would be a shortage of sand.”) As he aged and his influence waned, Greenspan was the go to guy for a brief while, but then Paul Krugman rose to the top.

Krugman is the most prolific and popular economic writer of the past few years, so his ideas therefore permeate the consciousness of the American thinking class, who of course all believe they are open minded and independent thinkers but really just repeat the things they hear on NPR, read in the NY Times, or watch on the Daily Show. Why pick up a book that might challenge your thinking when you can listen to pseudo-intellectual babble and pretend it’s gospel?

The Republicans put their faith in Rush and Fox News. The Democrats have their gods too, those I mentioned above. Those brave enough to think for themselves usually find that it isn’t worth the time, and no one cares anyway. A vote is a vote. How much time you devote to understanding the issues doesn’t factor in.

Comments

11 Responses to “You Are Not The Keynesian You Think You Are”

  1. You Are Not The Keynesian You Think You Are : Coconut Headsets | World Money Newsletter on February 6th, 2013 3:07 am

    [...] the rest here: You Are Not The Keynesian You Think You Are : Coconut Headsets Bookmark It This entry was posted in Money and tagged britain, critical, [...]

  2. Joe on February 6th, 2013 6:58 am

    You nailed it. This is the most accurate assessment of our current economic situation I have read.

  3. bingowings on February 6th, 2013 1:25 pm

    Yep, austerity definitely works. Just ask the British who’ve successfully trashed their wobbly economy using it.

  4. Rob on February 6th, 2013 4:31 pm

    You just proved my pointt bingowings. My point is you can’t get the economy on track without the short term pain of austerity. If you won’t take the pain, you will end up like Japan.

    The British will kick our economic ass in 3 years because they are taking their medicine now, and they will be healthier.

  5. Cal on February 6th, 2013 5:19 pm

    “Democracy will have to learn that it must pay for its own follies and that it cannot draw unlimited checks on the future to solve its present problems.”
    - Hayek

  6. Matt on February 7th, 2013 6:28 pm

    I agree and especially like your ironic finish - “no one cares anyway.” That is the real issue. As long as no one really cares, government will continue to prop up its own existence by nipping at the margins. It will not be until we have true independent thinking that the real issues of entitlement reform are tackled.

  7. Damian on February 7th, 2013 7:35 pm

    “I believe this will turn out the same way it did when the government tried to fix education and tried to fix home ownership”

    In what way did government ruin home ownership? Are you arguing that government had more of an impact than players in the private marketplace? Please tell me you’re not a believer in that tired old (and completely refuted) CRA argument.

    “The British will kick our economic ass in 3 years because they are taking their medicine now, and they will be healthier.”

    Want to bet on that? Their debt and deficit have only increased since they started their austerity measures. Thus, they are further in the hole, not climbing their way out. The magical growth, which was supposed to appear due to the equally magical confidence fairy have yet to show themselves. In short, none of that has proven to be true for countries that went with austerity.

    “Milton Friendman was king. He was witty, smart, and usually won debates with his great aphorisms. (My favorite may be “if you put the federal government in charge of the Sahara desert, in 5 years there would be a shortage of sand.”) As he aged and his influence waned, Greenspan was the go to guy for a brief while, but then Paul Krugman rose to the top.”

    Friedman was a great economist who was also, in many cases, wrong. His central political argument that the government caused the Depression was driven from his academic argument that the government made the Depression worse - note the switch there - from “didn’t help enough” (economic argument) to “caused” (political argument). This is a comical view given the recent economic crisis where private actors essentially worked to the greed principle and caused a huge bubble and eventually the destruction of the US economy and themselves (in some cases).

    He also argued that monetary policy was the chief tool to battle recessions/depressions - something the Ben B. would actually agree with. But whether you look at Japan or 2008, you’ll see that monetary policy, by itself, isn’t enough to increase aggregate demand.

    Greenspan is now famous for going in front of Congress to say that his central tenant - namely that economic actors would be well behaved because it was in their own self interest (a central tenant of Friedman’s own philosophy), turned out to be completely wrong.

    Krugman has risen to the top because he was correct in 2008 using his IS-LM model that correctly predicted:

    - That large government budget deficits wouldn’t drive up yields on Treasuries,
    - That a huge increase in the monetary base wouldn’t be inflationary,
    - And that the shift to austerity would weaken growth in the short run.

    I don’t buy your argument comparing these economists as equals - some are right, others are wrong, and it is obvious.

    The overall argument you’re making about the Keynesian economic approach thus doesn’t hold water because none of the data shows anything to support it. I’ve been hearing this same argument for 4 or 5 years - and I suppose on any timeline you might be right - but I remain skeptical.

  8. Rob on February 8th, 2013 1:58 pm

    Damian,
    RE: home ownership, both Clinton and Bush modified the rules to incentive and encourage Fannie and Freddie to take on more risk by being the backstop for more loans for people with bad credit. The private markets behaved irrationally because they knew the government would be the backstop.

    The British path doesn’t bother me, that is exactly what I would expect to happen. In the short term. But it will fall dramatically as their economy grows, and they will emerge stronger.

    Plus, you have to look at all sides of the issue. For example, there have been recent headlines about how our deficit is falling at the fastest rate since WWII, but they are misleading. The deficit increased, but much slower, and the economy finally started growing, off a slow base. So all these measures are “as a percentage of GDP,” which is only one way of measuring it and is misleading to the public given that the deficit didn’t actually decrease.

    Krugman was wrong. We have been seeing inflation, but only in certain sectors, not in the economy as a whole just yet. It will be here soon.

    But all of that misses one of the central points here, which is that our “stimulus” really isn’t Keynesian int he first place. If Obama was really a Keynesian, we would see more investment projects and fewer transfer payments.

  9. Damian on February 8th, 2013 2:39 pm

    “RE: home ownership, both Clinton and Bush modified the rules to incentive and encourage Fannie and Freddie to take on more risk by being the backstop for more loans for people with bad credit. The private markets behaved irrationally because they knew the government would be the backstop.”

    If that was the case, then why was the housing bubble a world-wide issue? Why was their also a bubble in Spain, for instance. Private companies behaved badly all on their own. Remember also that Fannie and Freddie were behind the curve on subprime and being outpaced by private companies. So it can’t be blamed on government backstop.

    Clinton is to blame for a lot of things - not regulating credit default swaps - but if Clinton created the housing problem, we would have seen it prior to 2000.

    The issue with housing during Bush was that he refused to make a simple modification to require confirmation of income - yes, that simple. That was actually one of the first things that Obama did when he came into office.

    “Plus, you have to look at all sides of the issue. For example, there have been recent headlines about how our deficit is falling at the fastest rate since WWII, but they are misleading. The deficit increased, but much slower, and the economy finally started growing, off a slow base.”

    You’re shifting the argument - my point is the deficit and debt in England are increasing as a result austerity. So while our deficit is still increasing, it is increasing more slowly, and we have postive GDP, while the UK and Europe are back in recession.

    “Krugman was wrong. We have been seeing inflation, but only in certain sectors, not in the economy as a whole just yet. It will be here soon.”

    Where are we seeing inflation in the last 4 years? Healthcare inflation is actually down, education inflation is still rising (different issue) - but where else are you seeing it? Show me the data.

    And saying “it’s coming” is the same argument I’ve heard for the past 4-5 years. Still hasn’t happened. Inflation is more likely to reappear if we have actual job growth - but the inflation risk and bond vigilantes have yet to appear.

    “But all of that misses one of the central points here, which is that our “stimulus” really isn’t Keynesian int he first place. If Obama was really a Keynesian, we would see more investment projects and fewer transfer payments.”

    Well, that isn’t Obama’s fault - he argued for more infrastructure and was turned back by the Republicans. He put in the tax cuts to essentially keep Republicans happy. This is another area that Krugman was correct when he argued that the stimulus was too small relative to the size of our economy.

    And now, Republicans are against any form of stimulus. So blaming Obama for the lack of Keynesian stimulus is a bit strange.

  10. Rob on February 9th, 2013 12:50 am

    Ok, I’ll try to consolidate some things to keep these comments from growing too long.

    – Real Estate
    First of all, I think Bush was a horrible president, and did more damage to the economy than any president before him. But I think Obama has one-upped him. I actually believe their economic views are very similar. But yes, Bush has many failures in the housing market. And if you look at some articles about the housing bubble, most pundits will say it began in 1997 with the Clinton capital gains deduction on home sales.

    I should clarify that I don’t believe the government backstops were the lone cause. It had to do with low interest rates worldwide, particularly post 9-11, although, not every place in the world had a housing bubble. Japan and Australia were coming out of theirs when we started ours, and Most of Europe was a little before us, because the ECB had a similar interest rate policy to ours.

    But the nail in the coffin, the thing that tempted the private markets to basically cheat, was the government backstop. Otherwise, I believe markets would have fixed this at some point.

    I will concede that it the role of Fannie and Freddie is hotly contested in the press even to this day. You have arguments that they drove the problem (http://reason.com/archives/2011/03/04/the-truth-about-fannie-and-fre) and Krugman has always said they weren’t (http://krugman.blogs.nytimes.com/2011/07/14/fannie-freddie-phooey/). But the chart in this article about GSE backed origination is what sways me to the side that they are to blame. http://www.theatlantic.com/business/archive/2010/06/did-fannie-and-freddie-cause-the-housing-bubble/57664/

    – Austerity and GDP Growth
    Government spending by definition raises GDP, so I don’t see why that matters. What I mean is, looking at GDP growth as your yardstick would say that any country that cuts deficit spending will see GDP shrink unless the private market can make it up. It’s like saying a debt fueled household still increased their spending because they added a new credit card… I don’t see that as a good thing.

    See this article on the difference between private and public GDP measurements. http://www.nationalreview.com/corner/339244/government-spending-and-gdp-veronique-de-rugy So GDP declines due primarily to government spending cuts don’t mean the same thing as private sector drops in GDP.

    We have to deleverage, and that will happen by inflating away the debt, flushing it out of the system by paying it off or defaulting, or growing the economy significantly faster than we grow the debt. If the latter was happening, I would expect to see unemployment lower.

    I’m willing to make specific prediction about Britain’s austerity measures… their unemployment rate will drop faster than ours beginning in mid 2013, through the end of 2014.

    – Inflation
    Land, energy, and many commodities are all up. It should hit the CPI by the end of the year.

  11. laurence haughton on February 19th, 2013 6:48 pm

    I read Keynes / Hayek, The Clash that Defined Modern Economics to learn more about both men and their opinions. I was not disappointed.

    I learned to admire Keynes for many reasons, the first and most important being his openness to disconfirming evidence. He wrote in his preface to The General Theory, “It is astonishing what foolish things one can temporarily believe if one thinks too long alone… If [a writer] is to avoid an undue proportion of mistakes, [he] is extremely dependent on criticism and conversation [including people like Hayek].” Another was his willingness to set specific targets and measure results to gauge his degree of correctness in his multiplier theory.

    I think we’d be much further along today in understanding the right path to prosperity and the proper kinds of interventions if economists (especially the Keynesians) had spent the last sixty plus years emulating Keynes openness and accountability.

  • About Rob

    Rob is co-founder of Backupify.com. He likes value investing, the Rolling Stones, college basketball, artificial intelligence, economic history and people who think independently.