Monday, 16 March 2009

What Keynes really meant

Russ Robert over at Cafe Hayek inquires into What Keynes really meant. He writes
What did Keynes really mean? It's hard to say. His masterwork is a bit opaque and has been interpreted by many generations of acolytes.

In the current environment, we are told that consumers aren't spending so aggregate demand has fallen. (This is typically discussed as if the reason for this drop is irrelevant). Therefore government must step in as the spender of last resort. This was the defense of the so-called stimulus package of $787 billion. Those who defended it did not defend it on the merits of what was in it, but rather simply on its magnitude. And many of those defenders (including Paul Krugman and Robert Reich) said it was not big enough.

Their basic argument is Keynesian in nature—that aggregate demand, C+I+G, must be boosted up to its former level and that this can be achieved through an increase in G. And according to the Administration (and the study it produced written by Jared Bernstein and Christina Romer), every dollar of government spending would produce 1.57 (or was it 1.54?) dollars of income.

The presumption is that it does not matter what G is spent on. The most important thing is to get spending into people's hands so that they will in turn spend it and the multiplier will kick in.

The presumption is that the multiplier is a constant. It does not matter how G is financed. It does not matter what G is spent on. It does not matter why C is down. G just needs to go up. This is silly pseudo-science.

The presumption is that if G goes up, C will stay unchanged. This ignores any possibility that people will be aware that their taxes are going to go up very dramatically in the future and they will do nothing in response.

The presumption is that the borrowing or printing of money to finance the increase in G will have no effect on aggregate demand.

The presumption is that the people who get the money from the government will spend it rather than save it.

These last points are empirical questions. Actual estimates of the multiplier are all over the map. We don't have a lot of evidence on either side that is reliable. Anecdotal evidence is generally restricted to World War II on the encouraging side and Japan's recent experience on the discouraging side.

I have argued that economists generally came down on one side or the other of the stimulus package based not on their economic understanding but on their political and philosophical biases. I still believe that. I think we're in macroeconomically uncharted territory.
Roberts is right in that The General Theory is "a bit opaque and has been interpreted by many generations of acolytes". No one seems to know what Keynes really meant. The point about people expecting future tax increases in worth noting. Insofar as the world is, at least partially Ricardian, an increase in G will not have the full effects proponents of stimulus think it will. Roberts also point us to this this debate between Brad DeLong and Michele Boldrin.

Boldrin's argues that simply increasing G is not sufficient to induce recovery.

1 comment:

PC said...

RE THE DEBATE:

I confess I had no respect for De Long prior to watching this, but hadn't realised quite how much of an oaf he is.

He betrays no interest at all in why the world's economies are collapsing -- the reasons why the bubble burst.

When it comes to the facts, his manner appears to be "Don't bother me, don't bother me, don't bother me."

His interest is only aroused by these wads of magic money, pulled from the government's hat, that will solve all of our problems by the simple expedient of keeping all the zombies walking.

For an economic historian, his "massaging" of economic history -- on things like Hoover's record, German and Italan depression history, and the year the US depression ended (and his apparent ignorance of the reasons it lasted so long) -- is more than just cynical, it's dishonest.

If he has to lie to make his point, which seemss simply to carry water for Team Obama, it means even he must be aware his point could not be made otherwise.

His bland oafishness in the service of political orthodoxy really is frightening.