John Maynard Keynes, R.I.P

Article excerpt

The late revered British economist John Maynard Keynes, whose 1936 treatise, The General Theory of Employment, Interest, and Money, changed the way many economists think about recessions, once wrote that "in the long run we're all dead." Well, maybe so ... for everyone but Keynes.

Keynes's ghost has haunted the halls of the Bush II and Obama administrations, where various "stimulus" packages were concocted. The Keynesian arguments undergirding the fiscal stimulus froth over the past two years went remarkably unrecognized in the media for their one-sidedness. The basic stimulus argument goes something like this: If the federal government engages in deficit spending during a recession, the added government expenditures (unaccompanied by tax increases) will boost "aggregate demand." Greater federal spending on a road, for instance, will create jobs for construction workers, who can be expected to spend some if not all of their additional income on, say, bread. Bakers now will have more to spend on, say, cars and so on.

National income stimulated by the initial government road project can grow by some multiple of the expenditure, the theory says. It can even be wasted on pork-barrel construction projects like bridges to nowhere, according to Keynes. He even dared to advocate that the government bury dollars in bottles. Entrepreneurs could then be expected to spend money digging up the bottles, unleashing the multiplier magic and reducing unemployment (in the same illusory way).

A stimulus package (and budget deficit) of, say, $1 trillion would morph in short order, stimulus backers have assured us, into a minimum of $1.5 trillion in additional national income - maybe even into $4 trillion or $10 trillion. Pick your multiplier, because no one in Washington or academe really knows what it is. Even the best of econometricians can't accurately assess the multiplier when the current crisis is "unprecedented," as widely claimed.

Fantastic, wouldn't you agree? Keynesianism offers the proverbial free lunch several times over.

But if it sounds too good to be true, it is. If such income growth were possible, the country and the world would now be awash in prosperity, given that the federal government increased the national debt by $1.88 trillion in fiscal 2009 and could run deficits of $1.6 trillion and $1.3 trillion in fiscal 2010 and 2011, respectively. Between 2012 and 2015 it will add at least another $3 trillion to the national debt. Why not go for even greater deficit spending, if Keynesian theory worked so magically? Of course, many Keynesian enthusiasts have recommended stimulus packages two and three times what the Bush and Obama administrations sought two and three years ago, with little to no recognition that an escalation in the size of the deficit can, at least beyond some point, curb any multiplier effect (if there were the prospects of a positive one) as the budget deficit rises and crowds out expenditures in private sectors of the economy.

In the 1960s Keynesianism was followed as fiscal religion, but by the 1970s economists found it to be a snare and delusion for a simple reason: The political version of Keynesianism is a one-sided theory, with almost total emphasis on what the federal government spends. It pays virtually no attention to the potential private -sector offsets to the greater deficit spending by government or to how current fiscal policies could have negative long-run real income effects that can feed the current generation's expectations of impaired futures. Keynesianism, in the form practiced in political circles, has no appreciation for how people's expectations can affect their current spending and investing plans.

The late great economist Milton Friedman frequently peppered Keynesian enthusiasts in the 1960s and 1970s with a remarkably simple question that needs to be remembered today: Where does the government get the money it spends on roads (or bridges to nowhere)? …