Would Keynes be a Keynesian Today?

“Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.”

John Maynard Keynes, Collected Writings, vol. XXVII, Activities 1940-46, p.122 .


First Baron Keynes (1883 – 1946) was one of the most influential economists of the 20th Century. His ideas about economic theory and policy is referred to as Keynesian economics, and emphasizes the use of fiscal and monetary policy to manage the economy and address problems of recessions, depressions and booms.

One of the two main components of the policy approach advocated by the Obama Administration and now under consideration by the Congress is often referred to as a “Keynesian stimulus package”, a policy program intended to strengthen the deteriorating economy by quickly increasing government expenditure and lowering taxes. The magnitude of the fiscal package is huge, and is said now to exceed $900 billion. It consists of a wide assortment of separate measures ranging from tax benefits and relief through transfer payments of various kinds to states, localities, individuals, non-profits, and corporations to spending on civilian and
defense infrastructure.

In the discussions about the package it is often assumed that the various elements in the package will be implemented in short order and the beneficial effects from the spending and tax programs will be seen in the immediate months ahead. However, as Keynes himself notes, it takes time to draw up bills for consideration, debate and pass the necessary legislation, identify and allocate its various provisions to governmental units responsible for actually implementing the details, and then, finally, to begin to spend the money, where spending in any event must be spread out over time. Only a small percentage of the bill would be spent by the end of 2010.

Keynes did of course recognize that at the depth of a depression characterized by a collapse in aggregate demand major fiscal initiatives would be necessary to rescue the economy from its distress. But we are not in a depression and it is not clear that the central problem before the economy can be overcome by stimulating spending. And as above Keynes understood very well that major spending programs are not a useful way to stabilize an economy, for they take too much time to implement.

I doubt Keynes would refer to the current stimulus bill making its way through Congress as a “Keynesian stimulus package”. I think he would see the problem before the U.S. economy for what it is: A housing boom promoted by failed government policies; Reckless borrowing on mortgages, credit cards, auto loans by consumers; Low saving by a public on a consumption binge; Excessively rapid economic growth combined with an overvalued dollar that drove a rising current account deficit to the point where foreigners questioned its sustainability; An incompetent and overcompensated financial sector that ignored the excesses developing in front of their eyes; and A people utterly oblivious to the problems accumulating in their economy, their polity, and their daily lives.

And I think he would see that what is needed is not more consumption expenditure and government debt increasing the scope and power of government but a restructuring of the U.S. economy that focuses on employment and income creation in the private sector.

A Dark Age of macroeconomics?

“Brad DeLong is upset about the stuff coming out of Chicago these days — and understandably so. First Eugene Fama, now John Cochrane, have made the claim that debt-financed government spending necessarily crowds out an equal amount of private spending, even if the economy is depressed — and they claim this not as an empirical result, not as the prediction of some model, but as the ineluctable implication of an accounting identity. ....

[B]oth Fama and Cochrane are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment — period.

What's so mind-boggling about this is that it commits one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship. Yes, savings have to equal investment, but that's not something that mystically takes place, it's because any discrepancy between desired savings and desired investment causes something to happen that brings the two in line. ....

That's actually the point of one of the ways multiplier analysis is often presented to freshmen. ....

So how is it possible that distinguished professors believe otherwise?

The answer, I think, is that we're living in a Dark Age of Macroeconomics. Remember, what defined the Dark Ages wasn't the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

And that's what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S[avings]=I[nvestment] doesn't imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession.”

Paul Krugman, "A Dark Age of macroeconomics (wonkish)", The Conscience of a Liberal (New York Times blog) (27 January 2009).

http://krugman.blogs.nytimes.com/2009/01/27/a-dark-age-of-macroeconomics-wonkish


Paul Krugman (1953-) is a professor of economics and international affairs at Princeton University, and a columnist for The New York Times. Earlier this year he won the Nobel Memorial Prize in Economic Sciences "for his analysis of trade patterns and location of economic activity".

Paul Krugman is at once one of the best and one of the most controversial economists commenting on economic affairs today. There is no doubt that his academic accomplishments in the areas of trade theory, economic geography, and international finance are worthy of a Nobel Prize. And there is no doubt that he is more than outspoken in his opposition to ideas he does not like, often in a "shrill" rhetorical style, a tactic that wins him few friends among the many he attacks. A Democrat, he was among the harshest critics of the Bush Administration and now is an Obama cheerleader. J. Bradford DeLong, mentioned by Krugman in his excerpt, is a professor of economics at Berkeley, and a Democrat and strong Obama supporter.

The past week or so Krugman turned his rhetorical guns on John Cochrane and Eugene Fama of Chicago and Robert Barro and Greg Mankiw of Harvard, among others, eminent economists all who happen to disagree with his view of the central policy question under public discussion: Obama’s Stimulus Package. Barro responded in The Wall Street Journal the other day (“Government Spending Is No Free Lunch: Now the Democrats are peddling voodoo economics”), Mankiw posted a response on his blog (“Krugman on Equilibrium Macro”), and Cochrane wrote up his views on the issue (“Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?”).

Suffice it to say that the four gentlemen (and others) accused by Krugman of living in a Dark Age of Macroeconomics are among the nation’s top macroeconomists. Their major failing is not that they do not understand macroeconomics, as alleged by Krugman, but that they oppose the Stimulus Package now being considered by Congress. Worse, at least to Krugman, is many of them suffer from the sin of being Republicans and therefore, in his view, could not have understood economics in the first place.

When faced with sharp criticisms of any policy position he advocates, it is typical of Krugman to change the subject from the merits of the policies he advocates to an oblique attack on the people who oppose him.

World trade has collapsed

“The Baltic Dry Index (BDI) which measures freight rates for bulk commodities such as iron ore and grains crashed several months ago, falling 96 per cent. The BDI – though a useful early-warning index – is highly volatile and exaggerates apparent ups and downs in trade. However, the latest phase of the shipping crisis is different. It has spread to core trade of finished industrial goods, the lifeblood of the world economy.

Trade data from Asia's export tigers has been disastrous over recent weeks, reflecting the collapse in US, UK and European markets.

Korea's exports fell 30 per cent in January compared to a year earlier. Exports have slumped 42 per cent in Taiwan and 27 per cent in Japan, according to the most recent monthly data. Even China has now started to see an outright contraction in shipments, led by steel, electronics and textiles.

A report by ING yesterday said shipping activity at US ports has suddenly dived. Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18 per cent year-on-year, a far more serious decline than anything seen in recent recessions.

"This is no regular cycle slowdown, but a complete collapse in foreign demand," said Lindsay Coburn, ING's trade consultant.

Idle ships are now stretched in rows outside Singapore's harbour, creating an eerie silhouette like a vast naval fleet at anchor. Shipping experts note the number of vessels moving around seem unusually high in the water, indicating low cargoes.

It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end. Analysts say this problem has been resolved, but the shipping industry has since been swamped by the global trade contraction.

The World Bank caused shockwaves with a warning last month that global trade may decline this year for the first time since the Second World War. This appears increasingly certain with each new batch of data.

[Charles de Trenck, a broker at Transport Trackers in Hong Kong,] predicts Asian trade to the US will fall 7 per cent this year. To Europe he estimates a drop of 9 per cent – possibly 12 per cent. Trade flows grow 8 per cent in an average year.”

Ambrose Evans-Pritchard, “Shipping rates hit zero as trade sinks”, The Telegraph (14 January 2009).

http://www.telegraph.co.uk/finance/4229198/Shipping-rates-hit-zero-as-trade-sinks.html


Ambrose Evans-Pritchard is International Business Editor of The Telegraph of the United Kingdom.

As reported in the January RSG World Economic Brief issued to students earlier this month global trade is expected to decline sharply in 2009. The Brief pointed out that both U.S. exports and imports fell significantly over the course of the past six months, with imports dropping faster than exports and the U.S. trade balance improving. Indeed, for much of the year exports had been a bright spot for the U.S. economy, the source for what slow growth the U.S. recorded in 2008.

This short discussion gives some idea of the magnitude of the decline that now seems to be underway across the world and its unprecedented scope. This is far more than a slacking of trade or even a decline in trade. It is a collapse in world trade that reflects a sharp decline in not just the overall level of production in the world economy but in the level of output produced in each of its main sub-components, primary products and manufactures, and in each of its main regions. Because it is a broad-based and worldwide decline in trade and production, it is going to be very difficult to reverse. Unlike what has occurred at times in the past, the world economy cannot serve as a catalyst for a U.S. revival; if anything, it will be a further drag on the U.S. economy.

The U.S. and world economies now face their worst crisis since the end of the Second World War. It is likely to be a long, deep recession both here and abroad.

What is an American car?

“The Treasury has pumped billions into two of the three American car makers with head offices in and around Detroit, hoping to avoid a collapse of what industry and
political leaders call the U.S. auto industry. ....

When it comes to the car business, however, consumers and Congress and the Obama administration are going to confront a tricky question: Just what is an "American" car, or for that matter, an "American" car company? ....

Thomas Klier, an economist with the Federal Reserve Bank of Chicago who has studied extensively the realignment of the American auto industry, wrote in an October 2007 paper that as of 2006 about 25% of the parts used in vehicles assembled in the U.S. came from overseas, and another 25% were manufactured here by foreign-owned parts makers. The Detroit companies wave the Stars and Stripes when they advertise their wares or look for loans in Washington, but when they talk to investors or the business press, they stress their aggressive efforts to promote "global sourcing," a code for, "Buy More Parts from China and Mexico."

GM, the most global of the companies with headquarters in Detroit, has highlighted to investors that it now sells more cars (and has more employees) outside the U.S., and that its best opportunities for growth -- assuming the company's restructuring is successful -- are in China, Latin America and other developing markets. ....

Consider Chrysler LLC. During the 1980s and 1990s, Chrysler was the most flag-waving, red-white-and-blue American car company among Detroit's Big Three. Company Chairman Lee Iacocca was a clear, loud voice accusing Japan's government and auto makers of unfair trade practices. Never mind that Chrysler had a long-standing link to Japan's Mitsubishi Motors Corp. and sold various Mitsubishi cars. Then, Chrysler sold itself to Germany's Daimler-Benz AG to create DaimlerChrysler. Not long afterward, the new German owners installed a German executive to run what used to be Chrysler -- and began promoting German engineering as a valuable attribute of
its cars.

Confused yet? It gets better. In 2007, Chrysler was reclaimed for America -- 80.1% of it at least -- by the U.S. hedge fund Cerberus Capital Management LP. But ... now Cerberus has reached a tentative agreement to peddle 35% of Chrysler to Italian auto maker Fiat SpA .... Should this deal be consummated -- and that's by no means certain -- Chrysler would once again be majority owned by corporations located outside the U.S.”

Joseph B. White, "What Is an American Car?", Wall Street Journal (26 January 2009).

http://online.wsj.com/article/SB123265601944607285.html


Joseph B. White is a senior editor for The Wall Street Journal.

Figures on the foreign input to the domestic production of any American-made product tend to greatly understate the external contribution of materials, labor and capital used in the production process. Imports are deeply embedded into everything produced in ways that cannot be easily measured, for example, in the machinery used to make the autos rather than the parts themselves, or even the machinery used to make the machinery. Both the ranks of auto worker and auto executives include the foreign born and the foreign trained and the technology they use on the job may well have been developed abroad. Shares of stock are owned by foreigners not only directly but indirectly through their ownership in mutual funds. It is simply not a useful question to ask whether huge multinational corporations are American or foreign. They are both to a degree that no one knows and no one can know.

At Hat Tip to Larry Willmore and Keith Acheson.

Ken Rogoff's economic forecast

“Prior to the 1950's, output drops of 15-20% in a single year were routine (admittedly, national income accounting was more primitive.) A number of academic
economists say we should simply tough it out as we did back then. Recessions have important cleansing effects, helping to facilitate painful restructuring.

But today's social, economic, and political systems – at least in developed countries – are unable to withstand a peacetime decline in output of 15-20%
within a short period. Massive stimulus and intervention – the US Federal Reserve's current stance – is unavoidable. One can only hope that the state can get out of the economy half as fast as it is getting in. Nevertheless, the distinct possibility that stimulus and restructuring may work is further cause to hope that the deepening recession will not morph into a full-blown depression.
...
2009 will be a tough year. Yet, absent a large-scale conflagration, there is a fair chance that 2010 will see a restoration of weak growth in the US, Europe,
and Japan, and probably robust growth in most emerging markets. The US economy may have lost a fair chunk of its mojo, but it will require a lot more bad luck and
policy blunders to get to a second worldwide Great Depression.”

Kenneth Rogoff, "Has America Lost its Mojo?", Project Syndicate (January 2009).

http://www.project-syndicate.org/commentary/rogoff52/English

[DOW: Harvard economist Kenneth Rogoff was formerly chief economist at the International Monetary Fund.

The degree to which modern macroeconomics has “tamed” the business cycle in the post-World War II period can be seen in the chart below, which shows the annual percentage change in real GDP over the course of almost half a century:


Source of chart: Bureau of Economic Analysis of the Department of Commerce.

Rogoff is right that even the worst decline in GDP forecast for this year does not compare with the deep downturns and sharp upturns recorded in the past. But let me quickly add that the combination of problems now before the economy are in some sense unprecedented in the post-war period, so a return to much more volatile growth of the past cannot be ruled out.

I, for one, unfortunately, am less hopeful than Professor Rogoff that the state will reduce its role once the current recession is over.]

Policy blunders in World War I and today

“Mark Thoma gives us Joseph Stiglitz and Martin Feldstein being interviewed by Charlie Rose. I listened to it last night, and I found it so chilling that it adversely affected my sleep. Two issues stand out.

1. Both of them are keen on re-working mortgages. Neither of them mentions non-owner-occupied housing or any of the other issues that make re-working mortgages extremely difficult. At one point, Stiglitz says that banks may be postponing writing down loans because they are waiting to see what sort of bailout they might get from the government. But he doesn't draw the obvious conclusion that government interference is the problem, not the solution.

2. Both of them are keen on trying a big stimulus. Stiglitz says that everything done so far has been a failure, but again he doesn't draw the obvious conclusion. Instead, he says we have to try something bigger and different.

I was reminded of the Battle of the Somme, one of the worst policy blunders of all time. Having experienced nothing but failure using offensive tactics up to that point, the Allies [in WWI] decided that what they needed to try was....a really big offensive. Just as Feldstein and Stiglitz pay no attention to the on-the-ground the housing market, the British generals ignored the impact of machine guns on men advancing over open fields.

My guess is that in 1916, anyone who doubted his own ability to direct an enormous offensive involving hundreds of thousands of soldiers would never have made it to general. Similarly, today, anyone who doubts the ability of a handful of technocrats to sensibly allocate $800 billion would never make it into government or the mainstream media.

How many people will have meaningful input in determining the overall allocation of the $800 billion stimulus? 10? 20? It won't be more than 1000. These people--let's say that in the end 500 technocrats will play a meaningful role in writing the bill--will have unimaginable power. Remember that what they are doing is taking our money and deciding for us how to spend it. Presumably, that is because they are wiser at spending our money than we are at spending it ourselves.
…
Once again, I am very happy that we are not fighting World War I. The Paulson/Obama offensives may be squandering resources, sowing confusion in households and businesses, and creating large financial imbalances. But they are not sending young men charging into machine guns.”

Arnold Kling, “The Stimulus and the Somme”, EconLog (8 January 2009).

http://econlog.econlib.org/


Arnold Kling is a noted economist who has worked for the Federal government for many years in different capacities and as a professor at several universities. He is a founder and co-editor of EconLog, a popular economics blog that reflects Libertarian thinking.

Joseph Stiglitz is a professor of economics of a liberal persuasion at Columbia University and Martin Feldstein is a professor of economics of a conservative persuasion at Harvard. Both are well known in the profession and have held high policy positions in government and international agencies. Both have advocated focusing on stabilizing the housing sector as a key to any recovery of the U.S. economy.

Kling is right to point out that everything done to date by the government has failed to improve the overall economic situation. So far, the government has tried to revive the economy by the early and continuing use of monetary policy beginning in 2007 to improve credit conditions, the first stimulus package of early 2008, the various Paulson/Bernanke TARP measures, the bailouts of Wall Street and the banks, the injections of huge amounts of capital into various and sundry financial institutions, the “loans” to The Big Three of Auto, the money given to foreign countries to help stabilize their financial systems, and an increase of several trillion dollars to the national debt. All this is less than a year and a half. Trillions upon trillions of dollars. Spending, tax cuts, grants, subsidies, guarantees, purchases of stock, injections of capital, special appropriations, changes in ownership to the public sector, you name it, every conceivable kind of policy action, all with the same result: Nothing in the way of progress.

But fear not!, the now government tells us. We’re gonna save you! We’re going to double down! Not simply more and more of the same, but a lot more. After all, Stiglitz and Feldstein recommend more. So what if the fiscal deficit exceeds 8 per cent of the GDP? So what if the dollar collapses? So what if we add trillions and trillions to the debt our children have to pay? That’s their problem, and we’ll just take credit for any progress we see.

Then again, maybe all this spending and faux tax relief isn’t such a good idea. Maybe Kling is right. Maybe the banks, the mortgage firms, the auto firms, Fannie and Freddie, and everybody else who expects to be “saved” by the government are simply waiting for the government to act before they do anything, so the situation continues to deteriorate? Maybe our current policies are crippling the economy rather than helping it? Maybe the banks and everyone else would solve their own problems and the economy would perk up, maybe even recover, if we just left it alone? Maybe the best thing that could be done is to have the government tell everyone to deal with your own problems your own way? It would certainly be cheaper.

Unfortuntely, politicians are like World War I generals. They want to be seen doing something, even if doing something is the same old thing that yields nothing and continues to stall a recovery.

How much do the rich pay in taxes?

“The CBO [Congressional Budget Office] has released a new report on effective tax rates (total taxes divided by total income). Compared with previous reports, it includes more information about thin slices at the top of the income distribution. Here are the total effective federal tax rates for 2005, the most recent year available:

Lowest quintile: 4.3 percent
Second quintile: 9.9 percent
Middle quintile: 14.2 percent
Fourth quintile: 17.4 percent

Percentiles 81-90: 20.3 percent
Percentiles 91-95: 22.4 percent
Percentiles 96-99: 25.7 percent
Percentiles 99.0-99.5: 29.7 percent
Percentiles 99.5-99.9: 31.2 percent
Percentiles 99.9-99.99: 32.1 percent

Top 0.01 Percentile: 31.5 percent

N.B.: These figures include all federal taxes, not just income taxes”

N. Gregory Mankiw, “The Progressivity of the Tax System”, Greg Mankiw's Blog: Random Observations for Students of Economics (4 January 2009).

http://gregmankiw.blogspot.com/


N. Gregory Mankiw is professor of economics at Harvard University and a former Chairman of President George W. Bush’s Council of Economic Advisors. His textbook is used in Regent’s Principles of Economics course. He is also a Republican policy advisor.

A note on the data: The Congressional Budget Office has derived the effective Federal tax rates on the basis of IRS data, supplemented by information from the Census Bureau’s Current Population Survey. The income of a household is measured as the sum of wages and salaries, proprietors’ and other business income, interest and dividends, profits from capital gains and pension income, and any monetary or in-kind transfer payments such as Social Security and Unemployment benefits and food stamps, school lunches, housing assistance, and the value of Medicare and Medicaid received. Federal taxes paid by the household encompass the total of individual income taxes, Social Security contributions and corporate income taxes, as directly paid or imputed. Essentially, the income and corresponding tax data of millions of households are ranked from highest (probably Bill Gates’) to lowest (probably that of some poor Regent grad student sinking under the weight of his growing debt) and then is divided into cohorts such as quintiles and percentiles, from which the above data have been computed.

Contrary to prevailing opinion, the data compiled by the CBO on taxes paid by different income groups show the United States has a highly progressive tax system. It collects in Federal taxes alone over 30 per cent of the income of the top one-half of one per cent of country’s income earners. In contrast, the poorest one-fifth of the population pays only 4.3 per cent of their income in Federal taxes.

The burden of taxes on the population is higher than the effective Federal tax rate indicates. First, it does not include state and local taxes. Second, it does not include the cost of compliance with the tax code, which is expensive and has generated a major industry of baffled accountants and confused lawyers. Third, the cost of government is not only appropriated through taxation. It is also the output that would have been produced had the tax burden been lower. High taxes reduce incentives for work, saving and investment. Economic growth slows and unemployment rises. The loss is difficult to measure but it must be substantial. Lastly, the burden of taxes is becoming increasingly centered in a smaller and smaller proportion of the population, a trend that is not healthy for the polity at large.

The burden of taxes today is now heavy and mounting everywhere, the complexity of tax systems beyond comprehension and compliance, their effect on economic performance negative and corrupting. Yet we seem headed for a substantial increase in the tax burden on Americans.

Cheerleaders for the welfare state believe higher taxes (particularly, higher taxes on those already paying high taxes) is the solution for all funding shortfalls as they press to expand the scope of government. But governments should be increasingly apprehensive about The Iron Law of Taxation B high and rising taxes inevitably bring strong and growing resistance followed by evasion and rebellion. Wise governments fear the economic effects and political consequences of raising taxes, and rightly so.

The economic stimulus package now under consideration will place an extraordinary burden on government finances in coming years, whether it comes in the form of spending or tax cuts. Any money borrowed must be paid back, either by higher taxes or by printing money. As noted in yesterday’s Tdj, it is not just that it is difficult when crafting a stimulus package to spend huge amounts of money efficiently and effectively or to distribute the benefits of tax reductions fairly. One also runs up against The Iron Law of Deficit Financing -- at some point investors become unwilling to finance the deficits and the credit worthiness of the government becomes so compromised it cannot function.

We are entering a very, very difficult moment for economic policy. If the stimulus is successful it will lead to higher incomes and an enhanced capacity to pay the increased debt associated with the larger deficits incurred by the higher spending and lower taxes comprising the package. But if it fails, or even if it in the end it proves to have been unnecessary as the economy recovers by itself, the stimulus package will leave in its wake a huge intergenerational transfer from our children to ourselves imposed by higher future taxes that must be paid on the higher debt. Let us pray that any package passed by Congress is successful and the current downturn in the economy is reversed.

But let me in closing note that the idea of allowing politicians to increase public spending or lower taxes for purposes of a temporary stimulus to the economy, even in as bad a situation as we are now in, is a dangerous one. It is not just that whatever is done is subject to the shifting and changing political tides of the moment. That is mere inefficiency, lamentable but passing. No, it is that the spurious rationales for reckless deficit spending and huge national debts become part of a permanent political culture where politicians find it impossible to control their appetites for spending, and the size and power of government ratchets up and up, never to be reduced. Let us also pray that stimulus package truly comprises temporary spending.

Lessons from Keynes for the current crisis

“The ghost of John Maynard Keynes, the father of macroeconomics, has returned to haunt us. ....

Keynes's genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge. He wished to preserve as much liberty as possible, while recognising that the minimum state was unacceptable to a democratic society with an urbanised economy. He wished to preserve a market economy, without believing that laisser faire makes everything for the best in the best of all possible worlds.

.... Contemporary "liquidationists" insist that a collapse would lead to rebirth of a purified economy. Their leftwing opponents argue that the era of markets is over. And even I wish to see the punishment of financial alchemists who claimed that ever more debt turns economic lead into gold.

Yet Keynes would have insisted that such approaches are foolish. Markets are neither infallible nor dispensable. They are indeed the underpinnings of a productive economy and individual freedom. But they can also go seriously awry and so must be managed with care. …

The urgent task is to return the world economy to health.

The shorter-term challenge is to sustain aggregate demand, as Keynes would have recommended. Also important will be direct central-bank finance of borrowers. It is evident that much of the load will fall on the US, largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak. Given the correction of household spending under way in the deficit countries, this period of high government spending is, alas, likely to last for years. …

The longer-term challenge is to force a rebalancing of global demand. Deficit countries cannot be expected to spend their way into bankruptcy, while surplus countries condemn as profligacy the spending from which their exporters benefit so much. In the necessary attempt to reconstruct the global economic order, on which the new administration must focus, this will be a central issue. It is one Keynes himself had in mind when he put forward his ideas for the postwar monetary system at the Bretton Woods conference in 1944.
…
As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us. The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible. We have done a disturbingly poor job of this in recent years. We must do better. …

As Oscar Wilde might have said, in economics, the truth is rarely pure and never simple. That is, for me, the biggest lesson of this crisis. It is also the one Keynes himself still teaches.”

Martin Wolf, "Keynes offers us the best way to think about the financial crisis", Financial Times (24 December 2008).


Martin Wolf is associate editor and chief economics commentator at the Financial Times. He was awarded the CBE (Commander of the British Empire) in 2000 for services to financial journalism. He is a visiting fellow of Nuffield College, Oxford University, and a special professor at the University of Nottingham. Mr. Wolf is a former World Bank economist.

The return of Lord Keynes as the major intellectual force on the current policy making stage marks a completely unexpected comeback by a great thinker whose ideas had -- or so I and others thought -- been superseded by Friedman, Buchanan, Lucas and Barro. While the ideas of Keynes were thought to be foundational and it was granted that much of our understanding of a modern economy derives largely from his work, uses his concepts, and tests his conjectures and assertions, it was nonetheless felt that at its core Keynesianism was much too simplistic in its short-term focus and its failure to incorporate adequately microeconomic incentives and rationality and it ignored the complexities of policy implementation. Keynes’ emphasis on government spending was seen as ignoring the difficulties of spending large amounts of money expeditiously and efficiently and in a timely manner. It also appeared that the impact of extra government spending that Keynes proposed was less than his theory predicted and that the increases in spending worsened the long-term budgetary outlook. While never completely displaced, Keynesian thinking was gradually supplemented by other streams of thought and eventually much greater emphasis was given to monetary policy as the main tool of macroeconomic management.

But now a Keynesian government spending stimulus and tax cuts are all the rage in Washington. President-Elect Obama has yet to put forward his “stimulus package” but it is said it might be as much as a trillion dollars, and amount equal to well over $3000 for every man, woman and child in the country. That’s a lot of money and there is not an interest group in the country that does not have its hand out. Granted the present economic situation is unprecedented (well, not really unprecedented, as current unemployment is about a percentage point below that of the downturn of the early 1990s and 2½ percentage points below that of the downturn of the early 1980s), and I suppose the government should do something. And there is nothing that a politician loves to do more than spend, so Keynes and his theories are now in vogue.

I wonder how long it will be before we once again conclude that pure Keynesian economics is an inadequate basis for policy formulation?

Thanks to Larry Willmore for the Tdj.