Keynesian economics wrap up

A few days ago Brett and Julio sparred over Keynesian economics in our Second Great The Long Run Great Debate II. (Not to give a lot away but we're thinking of having the third as a pay-per-view event in Lagos.) Now lest you think my job in this debate was walking into the ring in a bikini with the title card, you stand corrected. Actually, I thought that was my job but Brett and Julio pointed out that in The First Great The Long Run Great Debate 1.0, Brett did a postmortem q&a. Right. So that duty now befalls me.

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For Julio
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You took the anti side but I didn't get the feeling you were fully against the broader principles of Keynesian economics. Yes?

I disagree with the notion that tweaking the money supply is the way to boost consumer confidence. You have to deal with the root cause of the erosion in consumer confidence in order to turn it around. I agree that government spending has a stabilizing effect on the economy, that's easy math.

You state Keynesian economics is very popular with governments. What ensures governments turning off the pump?

Eventually the gas runs out and your friends will only loan you so much. But prior to that, checks and balances, to the extent that the form of government allows. The checks and balances include political parties, corporations, special interest groups, and last but least, the people. I'm an "appropriate" government type philosophically.

You state:

"Earnings become spending, spending becomes earnings, and back and forth in a continuous cycle. When something shakes consumer confidence, consumers hoard money and the cycle is slowed or interrupted."

I think this is known in Keynesian economics as the "paradox of thrift". Most people would agree we should save some money. Few people would agree we should spend everything we earn. Do Keynesians ever come up with a way of determining what's the right amount we should be saving?

The personal savings rate has dropped from over 10% in 1980 to below 1% until the recent economic crisis with no noticeable effect on GDP growth. The personal savings rate has now bounced back to 7.5%, no doubt coming from reduced spending and investments. Keynes would say that it depends. During good times, save. During bad times, spend. We do the opposite. The IS/LM model lets you play around with the idea but I've never seen a number quoted.

One interesting data point that I ran across is that the same has happened to the Japanese personal savings rate. It has dropped as low as 2% in recent years. That has been in part attributed to their aging population spending lifetime savings at a higher rate than younger Japanese can make up in savings deposits. We're seeing the same demographic trend here and can expect the same effect until us Boomers turn to dust.

And if people are packing money away, wouldn't banks have a lot of money to lend (especially given they can lend out more than they have in reserve)? Hence, interest rates are lower, business plans that didn't work at 5% interest now work at 4% etc.

Sure. That's the multiplier effect. The problem is qualifying for a loan today. The bankers pockets have deepened thanks to all that TARP money and accounting rule changes, but their arms also got shorter at the same time. This is institutional hoarding - the bankers are behaving like consumers.

You state:

"Of course the best indicator of any economic theory in trouble is when multiple schools emerge with fixes: Neo-Keynesians, New-Keynesians, and Post-Keynesians. Neo-Keynesians ruled into the 70’s but were attacked by monetarists such as Milton Friedman."

This sounds a bit like the creationist tactic to portray evolution as a "theory in crisis". Many of the micro details of evolution are up for debate but of course there's no debate in science as regards descent with modification, common descent, etc. Care to flame me back for lumping you in with creationist losers?

Actually, I'll join you in dumping all of the economists who dogmatically follow any economic theory in the same category as those who follow religious dogma. I'd cut them some slack though since they at least try to apply math and science. But sometimes they get it about as wrong as Quantum Intelligent Design Theory. That's what got the Keynesians in trouble the first time around and why all these off-shoots emerged. Think of it as the reformation of the Church of Keynes. Economists are just as infallible as the pope.

I noticed neither of you mentioned Korea or my friend Roseanne in your debate. Why do you think that is?

I know with certainty that the reason didn't mention either is because I didn't think of one and don't know the other. Hope that clears that up.

Now I have a question for you: on the Kelvin scale, where do you put the temperature of my cold capitalist heart?

Thanks for moderating the debate Karl. :)

[Regarding Julio's alleged lack of pity for "the little people": Julio, you stilled my disquiet. I, for one, would welcome you as overlord.]

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For Brett
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Are all forms of government intervention into the economy Keynesian? For example, regulating the financial market, is that Keynesian?

No, Keynesian econ refers only to the idea that government can help offset declines in GDP through spending. Regulation is a different function.

You argue against the argument "Government spending never ends; they become permanent entitlements and thus eternal debts."

You call it a non-sequitur. But would you agree it's like allowing someone to put their hand into the cookie jar? You do it once, it's hard to stop.

This non-sequitur argument is not valid applied against the theory itself, but it is a practical argument. Governments rarely control themselves when it comes to spending.

Debt rarely gets paid back. We simply pay interest on it forever as the debt is continually rolled over. If an economy can recover and grow faster than future debt, then the debt burden shrinks in relative terms.

You state

"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."

The danger, it seems, is paying me to dig a hole and then paying Julio to fill the hole. Or getting Brett to build a bridge to nowhere. The Japanese went crazy during their "lost decade" and built bullet train lines to cities and towns that wouldn't make economic sense (i.e., be under utilized) in good times. The down side is in good times you now have to maintain this stuff built in haste in bad times. So, in fewer words than I used to set up this question, how do you avoid it?

A few thoughts here: First, employing people to produce productive infrastructure projects is certainly a good idea. The "shovel-ready" criterion is a good start I think. The Japanese certainly did go crazy, but then again they never really had an unemployment problem and their infrastructure needed little improvement. Japan was certainly a botched attempt at stimulus.

Second, in a Depression, when unemployment is 15, 20, 25 almost 30%!!!, how wasteful a project is doesn't really matter. Employing people and breaking the down cycle is the key. Of course, the more productive the investment, the better, but it isn't a requirement. Even knocking down excess capacity (such as entire communities of empty houses) has theoretical benefit since those homes are an unproductive sunk cost that actually hurts balance sheets.

Third, on the idea that stimulus now borrows from future growth, I am not so sure.  The "pulling demand forward" argument against Keynesianism is the strongest in my opinion.  It makes logical sense to me up front, but I admittedly struggle with the ultimate effect. Does it really simply shift future purchases to he present? Or does stronger demand now create more prosperity, productivity, investment so that demand later is unaffected or even stronger? I don't know, but I'm not wholly convinced. Anyone have evidence? (Yes, I know taken to an extreme thought experiment where a gov tries to borrow as much as possible in order to create demand now, it leaves a problem later- but we aren't working on in an extreme linear thought experiment).

Alternatively put, doesn’t current investment lead to greater future productivity? Make the roads better now and it reduces the waste that is commute traffic for years to come; improve education and [obvious]; improve energy efficiency and you reduce future costs while reducing dependence on volatile inputs; update computer systems and get more efficiency later. (I realize many believe in the gov multiplier being smaller than 1, but that is tangential to this argument.)

Also, creative destruction seems an obvious argument against. Many of the companies that would go bust in a more extreme environment SHOULD go bust. We don’t want to keep them afloat. This is true, but won’t they go bust anyway? It may take an extra year, but they aren’t competitive anyway. Plus, dismantling too much economic infrastructure too fast is disruptive and anti-efficient (so to speak) in other ways. Bernanke argues in his papers that the financial intermediary function of banks and the stock market was so disrupted and impaired during the Depression that it actually delayed recovery by preventing investment.

Anyway, I’m not wholly convinced in the smoothing hypothesis just presented. I do think it needs a more thorough vetting though.

You state

"Occasionally, the systemic stabilizers can get so far out of whack that it doesn’t right itself without creating immense pain and suffering."

I think the counter argument is governments cause the economy to get out of whack with their Byzantine regulation and interventions. Financial people such as yourself are forced to come up with "creative" ways of getting around stupid ass government intervention and then this causes regular joes like me to be financially ruined and have to resort to making money doing unspeakable things on web cam for congressmen. This argument might be akin to a criminal arguing "you forced me to steal your car by not having an obvious car alarm" type thing but I seriously doubt it. Can you establish beyond a shadow of a doubt thermite did not bring down WTC7 errr I mean economies do not get out of whack because of government intervention?

Well, bad regulation can certainly lead to distortion, but the idea that free markets aren't irrational all by themselves is ridiculous. Should we blame Al Gore for inventing the internet because it ultimately resulted in a stock bubble? Should we blame the government for bank's lax lending and people lying on liar loans? Is it the government's fault that the people and corporate lobbyists have thwarted all attempts at higher fuel mileage standards despite EVERYONE knowing it is good in the long run? Free markets are the best idea, that doesn't mean they are perfect and it doesn't mean they don't need help or regulatory parameters.

You may have noticed that I keep referring to the use of Keynesian policy during a depression. That is an intentional nod to my true position, which is that it can work in extreme situations. Using it during typical, normal post WWII business cycle recessions is misguided, while implementation is rarely quick. Yet, in the extreme situation when fear begets fear and unemployment reaches 15, 20, 25%+, it is a different story. The positive sentiment change after years of decline can alone prime the pump. Effectiveness also probably depends on a government's capacity to borrow cheaply, strength (size) and duration of the stimulus. In other words, there are a lot of variables. I do think it can and does work in the right situations, but those situations are very rare.

As far as fiscal policy in general, I really think governments of all stripes should adopt counter-cyclical policies. Pro-cyclical policies such as state and local governments are clearly problematic. Federal policies fit into the "we'll never reduce the spending, but in bad times we'll increase it" camp. That method seems to be broken too as evidenced by our national debt. This concept is ripe for another post or discussion another time though.

I noticed neither of you mentioned Korea or my friend Roseanne in your debate. Why do you think that is?

"Roseanne" reminds me of a whiny TV show since I don't know your friend Roseanne. But I did pick up a bowl of instant Korean noodles for breakfast tomorrow. I can be lazy in the morning.