“Now, of course, liberals have always believed in Keynesian countercyclical deficit spending.” – David Brooks, Editor at The Weekly Standard, The Progressive Shift, NYT, March 18, 2013
“We are all Keynesians now.” – Milton Friedman, author of “Free to Choose”, December 1965
“I am now a Keynesian in economics.” – Richard Nixon, U.S. President, August 1971
(And if political actions speak louder than words, there is the cavalier treatment of federal deficits in the administrations of Ronald Reagan and George W. Bush, against the fiscal conservatism of Bill Clinton.)
So just what is this “Keynesian economics”?
The General Theory was about “Employment, Interest, and Money”, and how they interact in the real world of the modern capitalist economy.
According to Mr. Brooks, it’s about “countercyclical deficit spending”, i.e. government spending to boost the economy during a recession.
President Nixon had a characteristically subtler view. He made his statement when announcing the removal of the last vestige of the “gold exchange standard”, in response to a run on gold instigated by Charles de Gaulle, ever the French nationalist, who schemed to reduce the global influence of the U.S. and its dollar. Nixon realized his government could never hold enough gold to back a reserve currency that denominated trade around the world, and side-stepped the problem with a fait accompli. The result was the system of floating exchange rates we have today, not to mention the practical end of de Gaulle’s dreams of national greatness.
Sometimes the phrase “Ricardian equivalence” is bandied when asserting that government spending merely displaces private spending and so accomplishes zero stimulus, and is less efficient to boot. Apparently, invoking the name of an 18th century economist is intended to add weight to the argument, but it strikes me as a strawman. (The point of the argument, that is. Not David Ricardo.)
The serious arguments in favor of more spending assert that the economy is still held back by a lack of private demand. On the surface this might seem plausible, especially if the overhang of non-government debt accumulated during the Bush years is still a factor in restraining growth. But if so, there should be a measurable difference between what the economy could be producing right now, and what it actually is. In other words, an ‘output gap’, signifying underutilized capital and labor.
Using ‘potential GDP’ data from the CBO, and actual GDP from the BEA, the output gap was essentially zero in 2007. It rose to a trillion dollars in 2009. This makes sense, given the $500 billion drop in measured GDP over that time, as well as the $500 billion increase in potential output as the working-age population grew, technology advanced, and so on.
Since the recovery began, the gap has fallen, but only to $800 billion or so, and this has remained fairly flat for a year or two. So, roughly speaking, the economy has recovered by 20%, and this seems to jibe with the employment numbers. But it has a long way to go, and without much momentum.
The ‘Keynesians’ might have a point, then. Where the economy has unutilized capacity, it ought to be possible to utilize some of it without crowding out private spending. This is of interest not only to relieve present-day economic distress, but also to put the compounding of growth on a more favorable track for the long term.
What gives us pause, though, are the already high levels of US debt. What of the risk that additional hundreds of billions in public borrowing may force tax rises in the future that will not only be unpopular but will themselves constrain growth?
One answer might be that, assuming the economy does tack up its slack, the Fed will at some point begin to worry about having to moderate inflationary pressure. Raising interest rates is the usual approach, along with selling treasuries to sop up liquidity. At the same time, however, when the economy is heating up enough that we worry about inflation, it isn’t unreasonable to think that measured tax increases (or at least eliminating tax expenditures) might be very timely. In fact, to a ‘classic Keynesian’ (if it’s not too much an absurdity to use ‘classic’ in reference to as unconventional a character as Keynes), fiscal policy should be counter-cyclical. The time for public austerity is arguably when the private sector has become ‘irrationally exuberant’, not when it’s in the doldrums.
But there is also a risk in doing nothing, not to mention piling public austerity on top of private. Underutilized capacity does not just sit unused waiting for better times. Not indefinitely. Skills are lost with age and retirement. Proficiency deteriorates with idleness. Capital is consumed through obsolescence and lack of maintenance. Nothing lasts forever, and what is set aside today may no longer be available later. In the language of business, if we do nothing now we may just have to write it all off as a loss.
That’s a pretty ominous risk in itself.