The Failure of Keynesian Politics

by on February 16, 2011 at 7:29 am in Economics | Permalink

Let's accept for the sake of argument the truth of Keynesian economics. It is now clear that Keynesian politics has failed. But don't take my word for it. Here's Paul Krugman on the great abdication:

…without saying so explicitly, the Obama administration has accepted the Republican claim that stimulus failed, and should never be tried again.

What’s extraordinary about all this is that stimulus can’t have failed, because it never happened. Once you take state and local cutbacks into account, there was no surge of government spending.

If that sounds familiar let's remember that by their own admission Keynesians believe that Keynesian politics also failed during the Great Depression. Again, Paul Krugman on the New Deal:

…you might say that the incomplete recovery shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. (emphasis in original).

So we have had two major cases that massively favored Keynesian economics but Keynesian politics failed both times. Not that this should be surprising, Keynes himself told us that his theory was more suitable to totalitarian regimes:

The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire.

More recently, other people (including Paul Krugman as I recall although I can't find a good link) have said similar things about the chaos of democracy versus the Chinese government's ability to stimulate at will.

Now I will take a large degree of laissez-faire and the chaos of democracy over authoritarian political and economic regimes any day. I assume most Keynesians would as well. Thus, if we can't count on massive increases in government spending during a recession to mop up problems ex-post shouldn't we all, Keynesians and otherwise, be spending more time thinking about ex-ante alternatives to Keynesian politics?

What are the alternatives to Keynesian politics?  Greater regulation to prevent crises from occurring is a legitimate response, although one that I wouldn't necessarily buy into in all particulars. Along the same lines, increasing wage, price and real flexibilities (e.g. relocation flexibility and public and private savings flexibility) would benefit us in future recessions. Automatic stabilizers such as unemployment insurance are one area that has worked quite well. What other areas can be automatized? Funding for states? How about an automatic payroll tax cut tied to the unemployment rate? (fyi, Keynes favored the latter).  

More generally, we can probably get more agreement today on policies that will operate tomorrow than we can get agreement today on today's policies or agreement tomorrow on tomorrow's policies.

Addendum: Ezra Klein comments and here is Megan McArdle and here is Paul Krugman.

1 Tyler Cowen February 16, 2011 at 3:31 am

The only citation I have seen for when Keynesian politics "work" is…World War II. I consider that a devastating admission.

2 Dave February 16, 2011 at 4:03 am

My pet automated stabilizer idea is an an automated doubling of the R&D tax credit during and up to a year following any declared recession.

3 Scott Sumner February 16, 2011 at 4:22 am

Also note that Krugman uses only government expenditures. Apparently tax cuts no longer count as stimulus in the Keynesian model. That's good to know, in case any Keynesians try to attribute economic growth in 2011 (should it occur) to the late 2010 tax cut deal.

4 Andrew February 16, 2011 at 4:41 am

No, you shouldn't promise to spend near infinite money in the final year of life, and then what that screws your pooch offer death panels as the only alternative. Don't do THAT. Some ideas are dumb.

5 josh February 16, 2011 at 4:49 am

It's amazing that people believe that you can simply treat enormous numbers of human interactions as a black box where you can create a specific desired effect on one absurdly constructed aggregate by pulling some lever. Wouldn't all of this metal energy be better served making sure we have just the right amount of rain in Kansas next April to ensure an excellent wheat harvest. At least we can fairly precisely measure rain and wheat. Why do we assume every problem has a solution?

6 AB February 16, 2011 at 4:51 am

"But if $800 billion "stimulus" was actually no stimulus at all…"

Can you say "counterfactual"? US unemployment 2009-2011 w medium-size stimulus and Fed QE has been about static. US unemployment 1929-1932 with Mellonism and the gold standard went from 3 per to 24 per cent. Daniel Kuehn above is spot on.

7 Sebastian February 16, 2011 at 4:53 am

What Daniel says – if you think the problem is a demand shortage, any additional demand you can produce (or additional demand shortage you can prevent) is a good thing, even if it falls way short of what's needed to close the gap.

Also, I think no one disagrees that preventing a crisis is preferable. But why Alex thinks that, e.g., "automatic stabilizers" (which any modern Keynesian, including Krugman, _love_) are something about which there is any degree of agreement, I have no idea. You have heard of this organization called "Republican Party"?

8 Walter McGrain February 16, 2011 at 4:56 am

Doesn't a 14 trillion dollar deficit represent a triumph of Keynesian politics?

9 Bill February 16, 2011 at 5:34 am

Re: "Let's accept for the sake of argument the truth of Keynesian economics. It is now clear that Keynesian politics has failed."

Maybe the solution is a better informed voter? Better informed political discussion?

If someone said: "Let's accept for the sake of argument that driving while drunk will kill people, but we know that every year people will drive drunk, therefore let's not….

We should be capable of having better informed discussions, a better informed citizenry.

Finally, not only does this argument not make sense, but it could equally be said about any policy:

"Let's accept for the sake of argument that the federal budget should be balanced across a business cycle. It is now clear that balancing a budget over a business cycle has failed, as some will be tempted to cut taxes rather than run a surplus over the cycle. Therefore, let's continue to run deficits."

10 Jim February 16, 2011 at 5:40 am

Here's an automation for you: each year, X number of Congressman are forced into retirement.

X is based on the unemployment rate.

11 Rich Berger February 16, 2011 at 5:50 am

What is the real evidence for the correctness of Keynesian economics? It really does look like a faith-based system where no matter what happens, it is proved right.

12 Andrew February 16, 2011 at 5:53 am

Housing and construction permeates the entire economy, thus a housing bubble burst should not be expected to cause only overemployment and subsequent unemployment in direct housing construction, that's why Krugman called for the housing bubble! ;O zing!

But seriously, look how quickly that Keynesian success sputtered out with overcapacity saturating demand- and everyone loves houses. Look how we thought we were in a recession when we actually had no idea it was good times. In a TGS world where services are much more delicate than mass production, Keynesian production makes less sense. We knew there was a lot of demand for cars and roads. There is a lot less clarity now and a lot more flexibility is required.

Try to name a sure thing. You can now even make Coke in your own kitchen. The real thing, baby. Krugman thought housing was a sure thing.

13 Daniel Kuehn February 16, 2011 at 6:13 am

The real failure of Keynesian politics, we should remember, is at the state level.

The reason why government spending was fairly flat despite a huge increase in federal spending is because the feds were essentially filling a hole that the states were digging.

How do keep on pushing Keynesian politics AND prepare for the next crisis? Loosen state balanced budget requirements. Then federal fiscal policy will have some traction and states won't be hamstrung.

14 Lord February 16, 2011 at 6:17 am

I think you need to examine why it 'failed'. One reason is a naive conception of money, not of what it is but what they want it to be. Another is those that remain employed profit from recession. Another is those that prospered prior to it are punished by it, and people like to see others get their comeuppance. Education can help, but I doubt it would be sufficient. Work sharing would help prevent the second. Revisions in how the economy is supported and how money is created and added would help with the third. Direct injection into citizens' pocketbooks rather than banking institutions and financial professionals that failed miserably would go a long way.

15 DaveyNC February 16, 2011 at 7:08 am

@Chris, let me clarify. The states received a large chunk of the stimulus which they used to…pay down debt, mostly.
http://www.commentarymagazine.com/article/where-d

Unfortunately, that article is behind a paywall, but the pull quote makes the point.

Keynesianism is essentially throwing money at the problem and while those doing the throwing think they are "targeting", this is an example of the age-old technique of throwing shit on the wall. The shit that stick must be good shit. The states didn't follow the targeting that the Feds thought they would.

Truth is, the stimulus wasn't really a stimulus at all; it was political payola on a massive scale. Happens after every election.

16 Yancey Ward February 16, 2011 at 7:21 am

The federal government has run deficits of over 3.5 trillion dollars in the last two and 1/2 years. How much did state and local governments cut their budgets again?

17 Nick February 16, 2011 at 7:38 am

Krugman and other advocates of Keynesian economics would tell you that the stimulus was effective, to some degree (GDP and unemployment were higher than they would have been otherwise) but that far too little was done and that the money that was spent was spent in inefficient ways. You want a high multiplier on any "stimulus" money the government spends; i.e., for every dollar you spend, you want to see more than a dollar increase in GDP. Tax cuts are inefficient because some of this money gets saved by people or used to pay down debt, rather than spent, and so only some of the money goes into the GDP and helps employ out-of-work people. Tax cuts for the rich are the worst, because they're least likely to go out and spend their money in the US (invest overseas, etc.). On the other hand, if the government builds a bridge, it puts to work people (who likely were out of work) who then will spend almost all their salary on goods and services, which then put other people to work because of increased demand. The hope is that with a big enough boost to demand, you don't merely fill a temporary hole in GDP, but you jumpstart the economy by having people spend more money, which creates more jobs, which causes people to spend more money in a positive feedback loop.

This isn't the most intuitive concept to sell politically, but I don't think it's impossible either. Maybe the best way to go about it is to have the government save money when times are good and the government is running a surplus and earmark that money for jobs/stimulus projects when times are bad.

18 Rich Berger February 16, 2011 at 7:51 am

So if the states had not cut their spending, they would have got the money to maintain their spending from where? From the payments that they would have made to bondholders (assuming that DaveyNC is correct) or from their taxpayers? Now these groups have less, so isn't that destimulative? I know what the supporters will say – that government spending has a higher multiplier.

In the Keynesian view, it's irrelevant what the money is spent on and whether the money/demand came from those who earned it or from those who received it like manna from heaven. Sounds like a fairy tale. I have recently tried reading the General Theory again and I feel like it's an intellectual version of three card monte.

19 random grad student February 16, 2011 at 8:04 am

"In the Keynesian view, it's irrelevant what the money is spent on and whether the money/demand came from those who earned it or from those who received it like manna from heaven. Sounds like a fairy tale. I have recently tried reading the General Theory again and I feel like it's an intellectual version of three card monte."

I agree that the basic Keynesian view is incoherent. The New Keynesian view, however, is not, and you are clearly either unaware of it or have failed to understand it.

The point is that when nominal interest rates need to go below zero for the economy to be in equilibrium, they can't, and the "excess" of savings at the 0% rate forces real production downward. You can get this from basically any microfounded New Keynesian model (at least any model where prices are sticky enough for monetary policy to have real effects). In ordinary times, borrowing money and spending it forces interest rates upward, which is actually contractionary for the private sector; at the zero lower bound, however, when the government borrows money interest rates do not budge (their equilibrium value is already below zero!), and tightening the gap between the equilibrium rate and 0% improves the economy enough for spending to have a high "multiplier".

The classic multiplier story you hear in Econ 101 — where the government spends $1, the recipients of those funds spend 70 cents, and then 49 cents, etc. — is silly and simplistic. You have that right. But there are much more sensible models out there, which is why I'm always frustrated by people who talk about "Keynesian" economics (of the old Keynesian sort) as a relevant school of thought. The profession has moved on, everybody…

20 JSK February 16, 2011 at 8:14 am

Hmm… Alan Binder seems to disagree. http://online.wsj.com/article/SB10001424052748704

A third rate economist against Krugman and Binder. Yeah, i'm not even going to read what Alex wrote.

21 Rich Berger February 16, 2011 at 8:30 am

JSK-

You're very efficient. Why read what Alex wrote when you can just take it on authority?

22 justanothereconomist February 16, 2011 at 8:37 am

This paper seems to point to fiscal stimulus working quite well in 1939-1941, when spending was high, and the war hadn't begun yet in the USA.
http://www.nber.org/papers/w16380

Weak case right? Massive increase in spending when the USA had a large output gap, with unemployment plummeting.

23 pgl February 16, 2011 at 8:54 am

"What other areas can be automatized? Funding for states?" Alex hits on one of my favorite ideas – true countercyclical Federal revenue sharing!

24 orionorbit February 16, 2011 at 9:09 am

OK, you are completely misquoting PK here. He never said what you appear to have understood.

PKs position in both posts iss CLEARLY that keynesian policies were never tried, and since they weren't tried you really can't evaluate them in that context. I realise that his nobel must hurt a lot, I realize that people who bet against his predictions on interest rates 2 yrs ago and shorted treasuries lost a lot of money, but If you are going to disagree with him the least you can do is read his post.

25 Floccina February 16, 2011 at 9:15 am

Daniel Kuehn perhaps my understanding of Keynesian is wrong but is there a great difference in state and local Government spending reductions and business spending reductions? Is the Keynesian idea the idea that Government should replace all spending reductions dollar for dollar or is it the idea that new Gov projects will give suppliers confidence to borrow and so create a multiplier were the spending need not replace all the short fall?

26 Rich Berger February 16, 2011 at 9:49 am

Apropos of this post, this is pretty funny:

http://blogs.wsj.com/washwire/2011/02/15/white-ho

27 John Dewey February 16, 2011 at 9:58 am

George: "Economics will never be taken seriously so long as people believe in fairy tales like "boosting AD" as a solution. … That so many rent-seeking academics are more than willing to provide this veneer of "science" to such nonsense is an embarassment to the profession of economics."

I agree completely, George.

28 Barry February 16, 2011 at 10:27 am

Tyler Cowen: "The only citation I have seen for when Keynesian politics "work" is…World War II. I consider that a devastating admission."

First, Krugman covered that – he compare the magnitudes of stimulus.

Second, FDR was able to get massive growth rates using stimulus. His two problems were (a) he started listening to right-wing economists in 1937, and (b) the sheer magnitude of the fall in the years before him meant that massive progress still left people hurting.

Really, guys – a casual look at growth rates in the 1930's will shatter every right-wing lie told right-wing economists.

29 THS February 16, 2011 at 11:07 am

I would say that Krugman has an engaging response. And he's correct: many who don't want discretionary fiscal policy at the ZIRLB also don't want additional financial regulation or higher inflation targets or additional tools for the Fed.

They simply cannot express what they do want other than liquidation.

30 Lou February 16, 2011 at 11:26 am

I just threw out my copy of A Monetary History of the United States because Barry made some casual observations.

31 chris February 16, 2011 at 11:38 am

Look, here's what I would expect to be the obvious account of this, from the standpoint of someone adopting a Keynesian point of view: only in the face of a war is it really possible to persuade the majority of voters in a democracy to embrace robust countercyclical spending. Otherwise, those voters are only too susceptible to the seemingly "intuitive" argument that the right solution for the government in the teeth of a major economic downturn is the same as for them as individuals: to "tighten our belts".

So where's the devastation here?

Well, if your theory is correct, the devastation is a self-inflicted wound. The hard part is figuring out if there's any way to *stop* us from amplifying our pain by reacting to private-sector contraction with public-sector contraction.

32 Andrew February 16, 2011 at 12:00 pm

dedicated supply siders have a habit of becoming orthodox Keynesians overnight (Exhibit A: Bush, Paulson, Bernanke et al in '08).

What? First, they never weren't Keynesians we had multiple stimuli under Bush. Second, Paulson and Bernanke are bankers, the former literally, the second de facto. Third, Bush said "if money isn't loosened, this sucker could go down." He did not say "unless we build some bridges, this sucker could go down."

33 RD February 16, 2011 at 12:56 pm

Can someone point to the data on government spending that supports Krugman?

34 RD February 16, 2011 at 1:08 pm

I should have said, what are the arguments for why Krugman might be wrong on the data?

35 Steve Roth February 16, 2011 at 8:21 pm

EITC indexed to some measure of unemployment.

36 John Papola February 17, 2011 at 8:38 am

Here’s a nugget from the man himself…

In 1940, Keynes concluded that war might be the only way that politicians in democratic nations could rationalize spending enough to bring about full employment. “It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiments which would prove my case — except in war conditions,” he wrote in The New Republic.”

from: http://old.nationalreview.com/nrof_bartlett/bartl

37 Shane Pleasance February 17, 2011 at 9:33 am

Maybe governments just can't "fix" it? Just saying…

38 joeedh February 17, 2011 at 9:42 am

@John Papola, military expenditures also have the highest productivity gains per buck (much of our recent technological progress came from military research, including computers). That's probably why politicians favor defense spending so much.

Unfortunately, we've wrung all the economic benefits we're going to get from defense. After decades of crony capitalism, defense spending just isn't providing the boost it once did. It's too inefficient.

We've hit the limit of what I call the three "magic recovery" options:

1. The magic capital gains rate cut.
2. The magic Fed put.
3. The magic Keynesian option of spending more or taxing less.

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