Wednesday, February 20, 2008

Are We All Keynesians?

This week, The Economist has an Economic Focus article on Keynesian stimulus. In 1971, Richard Nixon, the former budget-hawk, strident anti-communist, and all around grumpy conservative, said, "I am a Keynesian now." To put his remark in context, Nixon's 1971 statement of faith was an eerie play on a 1965 headline from (what most of his Republican supporters would call) a liberal commie rag (Time Magazine) stating "We are ALL Keynesians now." In fact that headline was merely a quotation of Milton Friedman, monetary economist at the University of Chicago, and author of the anti-interventionist treatise, "Free to Choose." I guess the implication was that here was the last bastion of conservative economic thought, conceding that the Keynesian approach had won out.

But before long, supply-side ("cost-push") inflation (mostly from oil prices) created a resurgence of classical ideology favoring low taxes, balanced budgets, and laissez-faire. And this new blood in the field of economics, led by the likes of economists Robert Lucas, Robert Barro, Thomas Sargent, Arthur Laffer and journalists Jude Wanniski and Robert Bartley, had a valid point about the long-run implications of Keynesian policies. In fact, the Supply-side movement got its inspiration, not from disdain for Keynesians (although this was not wonting), but from the Austrian school of thought and Joseph Shumpeter (who predicted the eventual collapse of communism in the 1930s). This school of thought was acutely aware of the importance of politics and institutions in the efficacy of any type of economic system, but generally supported market capitalism. Their political voice was Ronald Reagan, at least rhetorically (most people debate how "conservative" Reagan really was – he ran humongous deficits, and pulled unprecedented amounts of executive "discretionary spending" out of congress).

Now, we've come full-circle. Clinton (William Jefferson) signed entitlement reform, balanced the budget, began talking about "market incentives," and promoted free markets through globalization and the WTO. For him it was a luxury, for the economy was doing well through no fault of the government, yet he deserves praise for not screwing it up. "W" did his part for the conservative cause by lowering taxes, but has done very little to balance the budget, promote market competition, or improve transparency and independence in the bureaucracy, all of which "true" supply-siders would say are as essential as tax cuts themselves for promoting long run economic health.

So where do we stand on the intervention issue? Does Keynesian intervention "work?" Yes. The short run is important, from both an economic and a political perspective. Intervention can smooth the business cycle and ease the pain of recessions, but not as much as the "old school" Keynesians thought, and it is usually poorly implemented, as The Economist points out. Two aspects are especially key: Timing and Targeting. Often times fiscal policy fails (or does more harm than good) because the political process cannot respond in time, and the "stimulus" hits as the economy is already recovering on its own. This causes the economy to overheat and produce inflation. In addition, governments need to have the discipline to reign things in during a boom. This usually doesn't happen because spending and other interventions create "rents" for interest groups and entrenched bureaucracies, who then lobby and pressure to have these benefits continued. Good targeting requiress that spending should be distributed in a way that maximizes impact. This is a political hornet's nest: Is the "right" target one that creates private sector externalities such as infrastructure and public goods, or is it one that eases the pain for workers and families impacted by the downturn? So, I'll leave it at that, and hopefully each of the 3 readers that see this might have some thoughts.



  1. You know my economic proclivities. Yet one of the problems I have with Keynesian policies is the informational burden they confer on the state.

    Or should the "success" of Keynesian economics be construed as implying that the information problem is much overstated in macroeconomics?

  2. This is an interesting point, although my initial pupose was to weigh the relative importance of demand-side shocks against that of supply-side shocks. In that vein, I tried to reflect on the economic history that may have led economic thought to favor one over the other. In short, I ignored specific debates, such as rational expectations and information constraints (or the "man on the spot" question) but it is also a fair criticism of Keynes.

    Markets certainly process information better. Bureaucracies are slow-witted, dumb, and often counter-productive when they do finally act. Keynes' analysis was blind to how the money was spent - it was more important THAT it was spent, for example as Freddy G. likes to say, "Tell one guy to dig a hole, and tell the next guy to fill it up behind him."

    Modern Keynesians are more aware of the subtle differences in the uses for expenditures and focus on coordination failures, imperfect markets, and externalities. In this case information and targeting both matter.