The end of Keynes

[philunderwood]

The end of Keynes

By Rich Lowry

www.JewishWorldReview.com |

Sen. Dick Durbin, the liberal lion from Illinois, pronounces the debt deal "the final internment of John Maynard Keynes."

The burial ceremony should be a nice, simple one after the violence done to the aged economist by the failure of the broad Obama stimulus program. The administration's serial overpromising in his name did more to discredit Keynes than a century's worth of broadsides by his intellectual enemies.

Nearly three years into the Obama administration, the unemployment rate is more than 9 percent, a grass-roots movement devoted to cutting government has the upper hand in the House of Representatives, and the debt of the United States could well be downgraded by Standard and Poor's. If Durbin thought that in these circumstances Keynes was heading anywhere other than a pine box, he hasn't been paying attention.

The debt deal is austerity designed by committee. It's late. It's needlessly complex. It's inadequate to our challenges and may not prove particularly functional. But it's austerity. That a Washington with a Democratic Senate and president has to go through the exercise of at least appearing to cut $2.1 trillion from the deficit with no guaranteed tax increases is a humiliating reversal for Keynes' self-appointed heirs.

Every time that Washington has a showdown, pundits and presidential historians gather on TV sets to lament the breakdown of our governing institutions and the end of compromise. But Congress is still perfectly capable of splitting differences. The debt deal gives a little something to all the major players in a jerry-built, two-part increase in the debt limit coupled with an initial $900 billion agreed-upon cut and at least a $1.2 trillion cut TBD.

House Speaker John Boehner gets less spending. Senate Minority Leader Mitch McConnell gets his cute trick of letting Congress disapprove a second debt extension while still giving it to President Barack Obama. Senate Majority Leader Harry Reid and President Obama get a debt extension past the 2012 election and a special committee that could possibly recommend tax increases.

Washington doesn't lack for the ability to cut such clever deals; it lacks the collective will to transform the entitlement state. So, it perpetually kicks the job over to a commission. Last year, the Bowles-Simpson commission released a report that President Obama promptly filed away in a drawer in the Resolute Desk. Now, the debt deal creates an all-new special committee to find the unidentified $1.2 trillion second round of cuts.

Realistically, it would have to find them in entitlements. Rarely, though, has a bipartisan committee been so primed for failure. The proposed committee will have 12 members, six from each party. It needs a majority of seven to make a recommendation that goes straight to a vote on the floor of the House and the Senate. Unless either party slips up in one of its appointments, the committee is very likely to deadlock.

As a spur to action, automatic spending cuts equal to $1.2 trillion kick in if the committee fails. The idea is to make these backstop cuts so ham-fisted and distasteful to both parties that they will have an incentive to agree. Democrats will have to stomach even deeper discretionary cuts than in the first round and some Medicare reductions, while Republicans take it on the chin on defense.

The automatic cuts are divided in half between security and nonsecurity. They would amount to a roughly $500 billion cut in defense, on top of whatever is wrung from it in the first part of the deal. In the new politics of austerity, Democrats can't spend more, but they can target the locus of the only spending to which they are reflexively opposed: the Pentagon. It is a sign of Republicans' fiscal hawkishness overcoming their national-security hawkishness that the party's leaders signed onto this deal.

The nation's debate has fundamentally shifted onto the ground of what kinds of spending to cut, and how fast and far. Keynes would be appalled, but as even Dick Durbin realizes, he's dead and gone.

[philunderwood]

www.qando.net/?cat=15

The Death of Keynesianism (Updated)

Published August 1, 2011 | By Dale Franks


Sen. Dick Durbin is an angry man, because he sees the debt deal as the death of Keynesian economics. For some reason, he appears to see this as a bad thing. In his comments today, discussing the debt ceiling deal, he noted:


“I would say … that symbolically, that agreement is moving us to the point where we are having the final interment of John Maynard Keynes,” he said, referring to the British economist. “He nominally died in 1946 but it appears we are going to put him to his final rest with this agreement.”

That’s a bit of hyperbole, but even if true…well…so what?

Lord Keynes had some valuable insight into how fiscal and monetary policy can work inside certain parameters­, but outside those parameters­, it fails. And I have no doubt whatsoever that even Lord Keynes would recognize that, once a country has accumulate­d enough debt, the debt itself becomes a drag on economic growth, and attempting to inflate your way out of it by piling on more debt is a solution worse than the disease.

We’ve actually learned quite a lot about how the economy works since the General Theory was published in 1936, not the least of which were the limitation­s of Keynesian theory in the 1970s. Keynes famously noted that politician­s are almost always influenced by the opinions of some long-dead economist. Like John Maynard Keynes.

Keynesian economics should be dead. If nothing else, the existence of stagflatio­n in the 1970s should have shown that Keynsian policy prescripti­ons were ultimately unworkable­. Indeed, the very existence of Stagflatio­n shows that several central tenets of Keynesiani­sm are simply flat wrong. The response to this is usually that the 70s were an aberration due the oil shocks of the Arab Embargo, and the subsequent price hikes enforced by OPEC.

I am, of course, quite well aware of this. I did, after all, live through it.

I am also aware that Keynesiani­sm regarded inflation and recession as being mutually exclusive-­-an idea that fostered a reliance of the Philips Curve, and constant seeking by the Fed to find the NAIRU. I am further aware that the Fed’s response to the oil shocks was a highly expansioni­st monetary policy that ultimately kicked off a wage-price spiral in a recession, rather than causing an economic expansion. Apparently, we found the limit at which expansionist policy ceased to be expansionary, and became merely inflationary.

What solved that problem was Paul Volcker’s Fed adopting an explicit Monetarist policy at the Fed to essentiall­y ignore interest rates and concentrat­e on money supply growth. As hard as it may be to believe now, markets would almost shut down on Thursdays waiting for the M1, M2, and M3 numbers from the Fed. We mostly ignore that Thursday money supply release now. It took a fair amount of pain, and back-to-ba­ck recessions in 1981-82 with 11% unemployme­nt to solve the inflation problem, but it did wring inflation out of the economy.

What we learn from all this is that Keynes had some serious policy limitation­s in the real world. I believe that we are currently discoverin­g more of those limitation­s.

We’ve actually learned quite a bit about how economies actually work in the 75 years since The General Theory was published. Over the last decade, for instance, a body of peer-revie­wed work has been developed (PDF) that shows that an excess of government debt serves as a drag on the economy, shaving at least a full percentage point off of annual GDP growth. And we’ve learned that this negative economic effect has a non-linear effect on economic growth as debt increases. I would submit that in light of this, that no matter how workable Keynesian theory may be in a regime of moderate public debt, with judiciously applied counter-cyclical monetary and fiscal policies, that it simply falls apart as the debt approaches 100% of GDP. One of the key problems is, of course, that we’ve rarely seen the high levels of public indebtedne­ss we’re currently experienci­ng, so prior to this decade, much of the work in this area was theoretica­l, except for data from highly indebted emerging countries, which may not be entirely applicable to mature economies.

Sadly, we’re collecting that empirical data now.

I’d also point out that we also don’t have to rely solely on 1970s stagflatio­n to note the failure of Keynesian prediction­s in the real world. One merely has to look at the wide-sprea­d Keynesian prediction­s in the immediate Post-WWII era that massive budget cuts to pay down the war debt, coupled with the demobiliza­tion of 12 million soldiers, would lead to a return of the US to a depression economy. Of course, no such depression occurred. Quite the opposite, in fact.

It was clear, even a decade after the General Theory was propounded, that it was…incomplete.

One more thing that relates the current level of indebtedne­ss is that attempting to apply Keynes over and over again–but only the deficit spending part–is that, in effect, you’re arguing that the Keynesian solution is to spend, spend, spend, not matter what the level of debt.

There’s simply no evidence at all that even Keynes would have bought into that sort of argument. Indeed, quite the opposite is true. Lord Keynes never argued for increasing public spending as a matter of course, but rather tempering spending with budget-cut­ting at the appropriat­e time. Properly applied, even Keynesiani­sm tends towards a balanced budget over time. What we’ve done over the past three decades isn’t Keynesiani­sm, it’s a perversion of it. We’ve spent like drunken sailors attempting to stimulate the economy, but we’ve never actually gotten around to cutting budgets and paying down the debt in the good times. We’ve simply accepted the new level of increased spending as the baseline.

My argument is that we’ve reached beyond the outer bounds where Keynes is applicable­. However relevant his observatio­ns may be in a regime of limited public debt and counter-cy­clical fiscal and monetary policy–wh­ich we’ve never really applied by the way, as we’ve ignored the budget-cut­ting bits–we’v­e simply passed the point at which his policy prescripti­ons can be relied upon, even if they are correct in other contexts.

If Keynesianism is dead, it’s mainly because we’ve killed it.

~
Dale Franks


UPDATE: From Billy Hollis in the comments:


One of the main reasons I have disdain for experts that are part of the political class is the Honors Economics course I took in 1975-76. The professor (an excellent one, and one of the few non-collectivist professors in the department) had us read and contrast John Kenneth Galbraith, who was the leading Keynesian proponent of the time, and Milton Friedman. Galbraith sounded like nonsense to me, and Friedman seemed logical and reasonably clear…

Pumping up the money supply artificially increases demand, trading present good stuff for future bad stuff (inflation, high interest rates, etc.). The only way you can believe that such a technique works in the long term is to assume people are stupid and will fall for the same short term thinking every time you try it.

I’d respond that what JKG called Keynesianism…wasn’t.

Keynes said that in recessions or depressions, the government should use deficit spending to pump more money into the economy. This extra spending would increase the money supply, and stimulate the economy. In addition, the government could cut taxes, allowing people to keep more of what they’d earned.

In good economic times, he said the government should operate at a surplus. That would keep the economy from heating up too fast, and set aside a store of money to be spent in the recessionary times. It would also reduce the money supply, and erase the inflationary pressures bought about by increasing the money supply during the recessions. Taxes could also be raised to help make up the previous budget shortfalls.

So, in a perfect world, the budget would balance, over the course of a business cycle. You’re still trading present good stuff for future bad stuff, but in relatively tiny increments. You really aren’t supposed to do it $14 trillion at a time.

What we had in the 1970s–and since–was half of Keynes. The easy bit. The bit that allowed us to spend, spend, spend, with nary a thought of ever applying fiscal austerity in the good times. Austerity is hard and unpopular. It’s easier just to spend money as a way to buy votes.

Since Keynesianism essentially requires the administration of wise philosopher-kings to administer it, democratically-elected polities have failed at implementing it.

Even more than that, Keynesianism essentially requires the ability to rather precisely target both the timing and amount of stimulus needed to ameliorate a recession, and the timing and amount of austerity to apply in an expansion to wring the expansionary and inflationary pressures out of the economy. But, absent a philosopher king who can operate in synch with the state of the economy, things begin to break down.

Timing the changes in fiscal and monetary policy are, at best, difficult in a democratic state. Messy political deals have to be made and legislation gets held up while waiting for amendments to satisfy some special interest, without which, too few politicians are willing to vote in favor. On the monetary policy side, the effects of policy changes aren’t realized for 8-16 months after a policy change, such as a change in interest rates. And, in either case, no one actually knows what the state of the economy is right now. At best we know what the state of the economy was last month, or three months ago, when the statistics were compiled.

Even at the best of times, with political players of unquestioned integrity, the immense difficulty of knowing the precise timing and amounts of expansionary or contractionary policy that is needed is a daunting task.

Theoretically, Keynes theory is elegant, and explains much about money-based economies. In practice, it’s so difficult and messy to try and implement, and so filled with negative incentives for the politicians who are asked to administer it, that it has simply proven unworkable.

Like communism, the fact that it’s never been properly implemented, or achieved the claimed result, raises serious questions about whether, in the messy world of real people, it ever can be.

[Ritty77]

From IowaHawkBlog:

Something else Obama inherited from W: a AAA credit rating.

Good one!

[twinder]

I'm quite sure that it will be the fault of W, or the Tea Party, that it was down-graded.

[philunderwood]

They’re already blaming it on the Tea Party for not allowing any tax hikes in their compromise. Moderates seem to be going along with the Tea Party won’t compromise BS.

[philunderwood]

To help the economy, stop trying

By Robert Robb

www.JewishWorldReview.com |

The U.S. political economy is in a bad and awkward place right now.

The economy appears to have stagnated with unemployment painfully high. As a result, elected leaders feel mounting political pressure to do something to get the economy moving again.

Yet, one of the things the economy needs to start moving again is for government to stop trying to help it.

People have a hard time understanding how economic growth can just happen on its own. This is particularly true for those on the left, who tend to view the private economy as just another government program. But it's also true among politicians on the right, who profess to have a superior understanding of how the private economy works but still propound short-term fixes for it.

Economic growth, however, does just happen. Wealth is created when voluntary trade leaves both parties feeling better off. Economic growth occurs when there is a virtuous expansion of such voluntary trades.

Government can help create an environment that facilities such a virtuous expansion, through growth-friendly and long-term tax and regulatory policies and quality public services and facilities. And government can do a lot to stifle such a virtuous expansion through the creation of an adverse environment.

Government, however, really cannot do anything to kick-start such a virtuous expansion. And attempting to do so, in fact, often contributes to the creation of an adverse environment that inhibits it.

Let's illustrate through a review of our recent economic history.

When the banks got in trouble in the fall of 2008, there was a consensus left and right that government needed to take action to prop them up. I disagree with this consensus, but let's assume it was correct and the actions taken to prop up the banks - providing public capital, expanding Fed lending facilities, a Fed guarantee of money market principal - were necessary.

About a year later, the banks had largely paid back the capital and were turning a profit (suggesting they weren't really that sick to begin with). So, that crisis was over. Yet the economy was in sorry shape.

Ever since, the government has been trying, unsuccessfully, to kick-start the virtuous expansion of voluntary trades.

The government embarked on a massive stimulus spending program. The only residual effect is a massive overinvestment in repaving, since that was about the only public construction projects that were truly "shovel-ready."

The Fed embarked on a massive monetary expansion. This has gone well beyond what was necessary to supply the banks with liquidity. It has been an attempt to kick-start the economy through low interest rates.

All that this monetary expansion has really accomplished is to severely punish small savers. If low interest rates could kick-start a virtuous expansion of voluntary trades, we'd all be driving Bentleys and living in mansions by now.

For further illustration, let's look at the housing sector. By the end of 2008, it was clear that there was a significant oversupply of houses. Over time, this would work itself out. People haven't lost their desire to live in a new home. When the oversupply was worked through, the new home construction industry would be back in business.

Government, however, was unwilling to wait and has tried numerous programs to try to revive the housing sector, even in the midst of what everyone acknowledges is a serious oversupply. They have all, predictably, failed.

All that's been accomplished by these governmental attempts to spark a virtuous expansion of voluntary trades is a huge increase in the federal debt, confusion in individual markets and uncertainty about the future value of the dollar.

Yet President Obama is about to give a big speech offering yet more ideas about what government can do to kick-start the economy. And Fed Chairman Ben Bernanke is mulling debasing the currency even further. It's as though the last three years hadn't happened.

In reality, Obama does more to help the economy when he plays golf. And the dollar would be sounder if Bernanke had just stayed in Jackson Hole.