Keynes was right; then subsequently abused

It is a delight to be with you here today, discussing the policy prescriptions of the great John Maynard Keynes. (I like to pretend like it is an actual, face-to-face Ivy League-style debate.) Though I disagree with my opponent, I do appreciate his view. Unfortunately for him, it is just plain wrong.

Like all lazy speakers, I’m going to begin with a definition. Continuing from the wiki post Karl cited:

Keynes contended that aggregate demand for goods might be insufficient during economic downturns, leading to unnecessarily high unemployment and losses of potential output. Keynes argued that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unemployment.

Despite the insults that rabid anti-Keynesians hurl at the supposed evils of this idea, the theory is really quite simple, elegant and plausible. Economic output, as defined by GDP, is the sum of private consumption + investment + government spending + net exports or GDP = C + I + G + NX. When a severe economic downturn occurs, C & I contract (net exports are already a negative and have been for decades, but are also relatively small in comparison so we can ignore it for now). If consumption and investment are depressed, the government can, at will, grow its expenditures to prime the pumps of demand. This simple and mechanical relationship is the crux of Keynesianism. Is this so hard to understand? Apparently so. Let’s examine the arguments against this brilliant observation before turning to the supporting evidence.

Argument against #1: Government spending never ends; they become permanent entitlements and thus eternal debts.

Analysis: non-sequitur. Governments failing to use short-term stimulus says nothing about the validity of the theory itself. This only speaks to the politics.

Argument against #2: Deficit spending results in massive debt and inflation.

Analysis: Poppycock! Deficit spending has never resulted in inflation. The largest deficits relative to GDP in the post WWII era (present situation excluded) were during the Reagan years which coincided with disinflation! Monetary policy results in inflation.

Argument against #3: A dollar spent by the government does not have the same multiplier as a dollar spent by private enterprise.

Analysis: This argument refers to concept known as the money multiplier (MM). When Karl buys pop tarts from Canadian Tire for $1, CT must pay for the pop tarts, which in turn must pay for the sugar, wheat, flour, electricity, etc. The power and water companies must pay their workers and for the coal, etc. And so on. A dollar spent generates more economic activity than just the one dollar. We call this the money multiplier. Some like to assert that when the government spends money, it doesn’t generate the same amount of downstream activity because by its nature, government spending is inefficient and wasteful. To this I say “so what!” By its very nature, during an economic downturn, productive resources are being underutilized, which causes a lack of investment and then further slack demand. During such conditions, establishing demand for goods and services- no matter how wasteful or inefficient- employs otherwise unused, idle productive capacity. Fuller capacity means revenues, profits, a need to employ and invest in new capacity. A dollar is a dollar is a dollar. Period. Furthermore, at cyclical lows all multipliers are lower than normal precisely because of unused capacity, so it is no wonder that government stimulus spending is thought to have a low multiplier.

Argument against #4: No one can calculate the amount of spending and duration needed in order to achieve full employment.

Analysis: Straw-man. The theory, as was always taught to me, is a counter-cyclical tactic. If it is misused or applied to that which it wasn’t intended, that isn’t Keynes’ mistake or a fault in the theory. Using it in an attempt to remove the business cycle is ridiculous.

Argument against #5: If Keynesianism is so great, why not increase government expenditures to 40% or 50% or 75% or 100% of the economy? That should work itself out brilliantly, you socialist, communist, fascist, moron! (or whatever you like to call me).

Analysis: In logic and many thought experiments, it often helps to examine the same situation from extremes to check validity. However, Keynesianism does not reject capitalism as a means to allocate resources as name callers would suggest. It is another straw man to say Keynesians want to destroy capitalism and replace it with government. Nothing could be further from the truth. It simply aims to boost overall economic activity while the economy rights itself from within.

Consider that an economy is a system. It is a system which allocates resources by balancing supply and demand. Occasionally, the systemic stabilizers can get so far out of whack that it doesn’t right itself without creating immense pain and suffering. Will it ultimately fix itself? Probably, if the people don’t revolt first. Which is better, insist on letting it fix itself and see if the country can hold together or try to help it along? An analogy might be a high fever. Sure, we all get them and usually survive after some pain and suffering. But then there are those pathogens that overwhelm the system and the natural mechanism- fever- that kills the pathogen. The fever gets so high and persistent, it begins to kill the host with - you -with dehydration, delirium and other symptoms! When such a vicious cycle of deterioration has begun, the answer is medicine. To hell with letting the body fix itself, give me the meds!

Before we take a look at the evidence suggesting Keynesian economic policy works, please remember that macro economics can’t be tested in the lab. The few times Keynesian policies were enacted in earnest, other things were going on too. So I’m going to concentrate on the biggest and baddest of the Keynesian experiments (and no, I’m not going to present Roosevelt’s New Deal as evidence; Too many bad policies worked against the good Keynesian ones to make any claims.) I can think of two solid examples of Keynesianism at work: WWII and the militarization of Nazi Germany. The latter is a better example and offers clear evidence that Keynesian spending can break the vicious cycle of depression. There is nothing less efficient and more wasteful than military spending and both ended the depression.

As for the assertion that Keynesianism is bunk simply because it spawned Neo-Keynesians, New-Keynesians, etc.- well, we started with gravity, progressed to relativity and then special relativity. We began with a simple atomic model of electrons, protons and neutrons. We ended up with quantum physics and now possible string theory. First came the Magna Carta; later came the U.S. Constitution. Theories get refined- especially the good ones. Need I say more?