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We Can't Even BEGIN to Debate Keynesian Stimulus Until We Know the Facts

George Washington's picture




 

Washington's Blog.

Keynesians argue that we must increase fiscal stimulus to prevent a full-scale depression.

They
argue that "deficit hawks" are wrong when they say that we can't afford
any more stimulus, and that worrying about debt in a crisis of this
size is penny wise and pound foolish, given the bleak unemployment
figures and other fundamentals. They also point out that America's debt
as a percentage of GDP is far less than Japan's.

On the other hand, those worried about the giant debt overhang point to the research of Minsky, Irving Fisher, Steve Keen
and Austrian school economists to argue that massive debt, endless
bailouts, government intervention in the markets, and the failure to
write down worthless assets and "purge malinvestments" from the system
are the main problems.

Many also argue that the 1930s Keynesian
stimulus programs did not work, and that the Depression did not end
until World War II. And they also argue that every dollar in additional
debt incurred now is another burden added to our childrens' shoulders.

Who is right?

Before deciding, you might want to look at two pieces of data.

Different Bangs for the Buck

Initially,
many Keynesian academics argue that it doesn't matter where the
stimulus money is spent, just as long as it is spent on something.
However, this is untrue. For example, it should be obvious that
spending in some areas will have more and quicker turnover (increasing
money velocity) as compared to others. And, in fact, economists have
documented that some types of stimulus spending have more bang for the buck than others.

So
it is idiotic to talk about "fiscal spending" in the abstract. Without
a cost-benefit analysis as to each category of proposed spending, any
analysis is hollow.

Aggressive Fiscal Stimulus Only Buys Two Quarters

Moreover, as former chief IMF economist and MIT professor Simon Johnson points out:

Perhaps the best analysis regarding the impact of fiscal policy on recessions was done by the IMF. In their retrospective study of financial crises across countries, they found that nations
with “aggressive fiscal stimulus” policies tended to get out of
recessions 2 quarters earlier than those without aggressive policies
.
This is a striking conclusion – should we (or anyone) really increase
our deficit further and build up more debt (domestic and foreign) in
order to avoid 2 extra quarters of contraction?

Indeed, many experts say that continuing to cover-up the fraud which led to the financial crisis will extend the crisis for many years.
In other words, failure to investigate and prosecute those responsible
for bringing about the crisis may extend the crisis longer than any
failure to spend more on stimulus.

(And investigations and prosecutions for fraud - unlike stimulus spending - would not increase America's debt or tax burden.)

A real debate about whether we should spend more on stimulus - and
if so, what types of stimulus - cannot even begin unless and until the
aforementioned data is considered.

 

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Tue, 11/03/2009 - 01:09 | 118023 Anonymous
Anonymous's picture

Maybe it's not just Economic Theory that's the problem; maybe there's a problem with Accounting Theory, too:

http://www.professorfekete.com/articles/AEFRevisionistTheoryHistoryOfDep...

Or hell, maybe it is just Economic Thoery:

http://www.professorfekete.com/articles/AEFCausesAndConsequencesKondrati...

Mon, 11/02/2009 - 22:55 | 117907 HayeksConscience
HayeksConscience's picture

GW, great article thanks.  Do you find it curious that the Austrians can refute the Keynesians but they cannot refute the Austrians ? 

Can the current system work if credit expansion is limited to GDP growth and interest rates are set by the market (as some have suggested)?  IOW, what constraints imposed on the system make it sustainable versus generating the boom/bust cycle.

Mon, 11/02/2009 - 21:55 | 117854 BennyBoy
BennyBoy's picture

Oh c'mon, let's keep repeating the same fraud, er, mistakes over and over.

Who's gonna notice? Congress?!

GS, JPM, C, BAC own congress

Mon, 11/02/2009 - 22:46 | 117808 Steak
Steak's picture

I'm quite glad that GW brought up the issue of different types of spending having different multipliers. 

I for one find the Keynsean output gap calculations insufferable.  They have assumed away all human considerations and qualititative judgements and reduced the study of economics to glorified accounting, minus the concept of a balance sheet of course.

If one actually looks at data in the real world (and I'm infinitely grateful that GW focuses on data above all else) then we see the M1 multiplier has now logged its lowest reading ever.  I guess "stimulus" that is nothing more than plugging holes in state budgets doesn't really go that far in this world.

This is a must watch datapoint for any interested in the world as it is and not as exists in the fantasylands of Keynsean economics:   http://research.stlouisfed.org/fred2/series/MULT

Mon, 11/02/2009 - 20:53 | 117778 Anonymous
Anonymous's picture

From various personally known anecdotes from those in business and from the various statistics coming out, injecting money into the economy got it moving again. Last I checked, most people depend on that economy for their welfare. Article I section 8 makes that the government's job--taking care of the public's welfare.

Is the complaint really about when and how much? Or just the general, constant shots across the democratic bow?

If the financial rules had not been weakened, or had been better enforced, between say 1998-2008, the mess would not be so bad. Why the hurry to blame someone now? Could it be because of who they are rather than what they actually did?

Mon, 11/02/2009 - 22:48 | 117903 Anonymous
Anonymous's picture

It's Promote the General Welfare. Not establish nor provide. Combine abuse of that clause and the ICC and you have the makings of Republic devolving to Democracy, devolving to anarchy.

Not my opinion....it's history. Enjoy your punch.

Mon, 11/02/2009 - 18:09 | 117605 ahab
ahab's picture

"But economic activity comes from spending, not saving. If you want to avoid the use of debt to support your spending, you're going to be stuck with a slower economy."

wow-

you are so smart-

and can ever expanding debt be the cure-

must be- because you say so-

like Bush said- "go out and buy something"-

appears you and he think alike- great minds and all

Mon, 11/02/2009 - 17:51 | 117590 Anonymous
Anonymous's picture

"May you live in interesting times." -Yiddish Curse

Looking askance at what could be the most crippling depression in human history (and I don't believe that to be hyperbole), my frustration with Keynesians knows no bounds.

The idea that government spending stimulates its conjoined economy seems, on its surface, a simple one. If the people are not spending money on things, and the government can not persuade them to do so, then said government can force the issue by spending money on goods and services from the private sector, reversing the downtrodden market psychology. (This is, I know, an oversimplification of Keynesian economic theory, but let's face it, he wasn't that deep to begin with...)

This ignores one fundamental fatal flaw in economic reasoning: The government has to get the money from somewhere. The State of California may get away with passing "IOUs" for a short while, but "IOUs" won't meet the payroll.

Thus, governments have only two options: Raise taxes or raid the global capital markets.

Raising taxes is the preferred method of dealing with increased expenses, but comes with a minefield a fiscal mile wide. Taxed activities lose financial momentum, and revenues eventually decline. Look no further than your nearest smoking friend, who has likely changed to a cheaper brand, cut down on his consumption, or quit altogether. End result: higher taxes, in this case on cigarettes, results in lower revenue.

The capital market route is easier for politicians to follow. Taxpayers do not see the result of the resultant debts, at least not directly. But every dollar taken out of the capital markets is a dollar that is not available for private sector investments, and there is no guarantee that the dollars in question will ever find their way back into the capital markets. Instead, much of it circulates for a short while, before being sunk into either gold or some other scheme or even under a mattress.

The fact is, most of this "stimulus spending" is being used to curry favor with corporate donors and to reward supporters and friends, and this has always been the case.

Bottom line: Never trust a politician (or an economist, for that matter) who tells you they know a sure-fire solution for any given problem, no matter which side of the political spectrum on which they squat. The truth most always lies somewhere in the middle...

Mon, 11/02/2009 - 22:42 | 117895 Anonymous
Anonymous's picture

But we will tax sugar, and sugar is bad....right??

Mon, 11/02/2009 - 17:17 | 117561 Daedal
Daedal's picture

A real debate about whether we should spend more on stimulus - and if so, what types of stimulus - cannot even begin unless and until the aforementioned data is considered.

I disagree.

To state that not enough evidence exists to prove or disprove Keynesianism is to ignore history altogether. Without going into an economics lesson within this post, let me just passively state that there is substantial evidence (presented by the likes of Amity Shlaes, Mises, Rothbard, and others) to indicate that Keynesianism causes the problems it claims to treat.

 

Mon, 11/02/2009 - 19:20 | 117680 Anonymous
Anonymous's picture

+1
WWLvMD?

(What Would Ludwig von Mises Do?)

Mon, 11/02/2009 - 18:06 | 117604 Econophile
Econophile's picture

Amen, Brother Daedal.

I would also point out that it has never actually been proven to work theoretically, much less empirically. Krugman made an attempt to do this by pointing to the 1950s work of Keynesian economist E. Cary Brown. All Brown did is tweak the basic K formula, apparently using a sky hook, and declared it to "work." George W. needs to refer to the work of Hayek and Mises on what Hayek called the "scientistic" approach used by econometrics.

It didn't work in WWII, the Depression, or in Japan, so why would it work here? And who believes all those Keynesians in the IMF?

Mon, 11/02/2009 - 18:56 | 117573 George Washington
George Washington's picture

Elsewhere, I'm being slammed by Keynesians for attacking Keynesian dogma ...

I'm being hammered by Austrians for not debunking Keynes altogether ...

This is written down the middle for a wider audience, so that even Keynesians start thinking about it.

Mon, 11/02/2009 - 17:23 | 117567 docj
docj's picture

+1.

Well said.

Mon, 11/02/2009 - 16:49 | 117534 DaveyJones
DaveyJones's picture

"many experts say that continuing to cover-up the fraud which led to the financial crisis will extend the crisis for many years...Failure to investigate and prosecute those responsible for bringing about the crisis may extend the crisis longer than any failure to spend more on stimulus."

 

 

It's almost as if....the government doesn't want to prosecute these people. Almost like the bad guys are... their friends. Weird.  

 

Mon, 11/02/2009 - 16:25 | 117509 Anonymous
Anonymous's picture

The thing I love about conservatives is how they can use whatever data they like to support any conclusion that's already ingrained into their heads.

If the author actually ever read Steve Keen (who's one of about a dozen economists GLOBALLY to predict the global financial crisis), he would know that Keen is absolutely NOT against counter-cyclical Keynesian stimulus. Read his blog at debtdeflation.com/blogs, and you'll see that even his most recent entry discusses how Australia's stimulus, which was the largest of any OECD nation (by share of GDP), helped Australia avoid even a recession to this point.

Similarly, Minsky's point was that capitalist economies are inherently unstable, and that "leaving it to the free market" will always lead to events like we've just experienced ... not that government should just stay out of it, and leave it to the pros.

Regarding the silly statistic about stimulus ending recession only two quarters earlier .... I'm sure that's correct, on average. Most recessions, however, aren't nearly as bad as this one, so the decision to use fiscal stimulus isn't as critical. In this case, it can make the difference between a recession and a depression. And please, no more ridiculous comments about how the New Deal didn't avert the Great Depression. FDR didn't take office until 3+ years into the Depression.

Finally, don't conflate the issue of Keynesian stimulus with the failure to prosecute fraud. They're independent issues. Keynes didn't say anything about letting bankers steal our money being good for the economy. Don't try to associate the two policies in a feeble attempt to discredit an economic strategy you just don't agree with.

Mon, 11/02/2009 - 22:37 | 117890 Anonymous
Anonymous's picture

Um...New Deal did not avert TGD 1.0...and was started by Hoover in the first place. Unemployment...still ~15% while we were sending a large portion of the work force off to die.

Map TGD 1.0 against the recession around 1920, which ended rather quickly...include Hoover's urgings for "stimulus" for a little perspective on just how Lassez Faire he was.

Right now the only jobs being created by stimulus are govt sector. What happens when that stimulus $ runs out.

Keynes methods are just fingers in the dam. Suggest reading about Broken Windows.

Mon, 11/02/2009 - 16:01 | 117479 Anonymous
Anonymous's picture

"They also point out that America's debt as a percentage of GDP is far less than Japan's."

It seems that most of our GDP over the last 15 years or so has been built on the back of ever-increasing debts, though, so in the end the structure can't be sustained. If the debt was largely separate from industries that were driving GDP I could see this argument having some merit, but that isn't necessarily the case with the US. The debt seems to actually BE our GDP.

Mon, 11/02/2009 - 16:34 | 117519 Anonymous
Anonymous's picture

"The debt seems to actually BE our GDP."

You say that in kind of a cutesy way that indicates that you don't fully understand that your statement is actually true.

What do you think money is? You're not one of those who think that money comes from the printing press at the Federal Reserve?

The vast majority of it comes from private debt. Bank loans, and the like. You may have this quaint notion of personal finance that tells you that debt is bad (and I'd agree with you ... hell, I paid off my mortgage in my early 30s), but in the broader economy, debt is money. Debt creates purchases, that gives someone else their sales.

If you want to complain that the government is just spending, spending, spending, fine, go ahead. But economic activity comes from spending, not saving. If you want to avoid the use of debt to support your spending, you're going to be stuck with a slower economy.

There are certainly alternate monetary systems we could be using, but for the last few hundred years, we've been in a credit economy. Until "fiscal conservatives" realize this fundamental truth, they're never going to be able to translate their own personal financial success into a strategy that excels on a macroeconomic level.

Tue, 11/03/2009 - 01:41 | 118045 Anonymous
Anonymous's picture

And until the New Keynesian Movement now prevalent understands and faces that the sustainability of debt is not unlimited, we will keep feeding excess capacity. There is NO way to get out of this without great social cost. It can be bad now or worse later. I could quote Mises, but why bother.

Tue, 11/03/2009 - 02:59 | 118085 covered
covered's picture

The blog hosts here at ZH are big on anonymity, which I think is great. There are some good comments by different "anonymouses" interspersed in these threads that I'd like to respond to but it gets sort of confusing sometimes. Could you guys stay anonymous if you picked out a handle, even if it is like George Foreman naming every one of his kids "George?" (Like 1-7)

Mon, 11/02/2009 - 22:24 | 117880 Anonymous
Anonymous's picture

There has to be a pool of savings from which to lend or spend.

Either way savings is a pillar of free markets.

Mon, 11/02/2009 - 23:36 | 117946 Anonymous
Anonymous's picture

I thought trade was the pillar of free markets?

Tue, 11/03/2009 - 03:51 | 118101 Anonymous
Anonymous's picture

Savings or stimulus, the same thing, a stash. Does nothing till it is spent and it is the bet that is the pillar of the free market. The freely made bet to be lost.

Mon, 11/02/2009 - 18:33 | 117632 Winisk
Winisk's picture

Like many on here, I'm trying to gain a better understanding of economics.  I'm grateful for the Zero Hedge team.  From my overly simplistic viewpoint, it seems to me that excessive spending and debt accumulation caused this mess.  You can hardly attribute our current slower economy on too much savings.  I would suggest that the Keynesians, with all the money stashed away, should start spending it so the rest of us can benefit from the stimulus as well.  

Mon, 11/02/2009 - 15:42 | 117464 jh69052
jh69052's picture

I feel that the Keynesian model took on a radically different form after the industrialized world moved away from the Bretton-Woods fixed exchange system. Now, the Keynesians could argue that fiscal stimulus and the circulatory movement of money could be acheived as a result of increased printing, thanks to the Fed. Keynes' model made much more sense when the quantity of money was fixed.

On another point, I think that the bailouts have been inadequately allocated to the productive economy. Money that stays in the financial sector does nothing for the real economy. One could argue that the US's productive economy has shattered (see Michel Chossudovsky, globalresearch.ca) due to import driven growth, which has been taking place for almost 30 years.

Another point, what if this economic contraction is a direct result of an oil production decline rate of about 7-9% each year since 2005? Peak oil experts ( see Michael Ruppert, Colin Campbell, Richard Heinberg) argue that our economic system developed and is, correspondingly, dependent on an abundance of cheap oil, which is, undoubtedly, in decline. If this is the case, the money that these "Keynesians" argue should be used for stimulus should instead be used to prepare our energy grid for a massive change which would take atleast 30 years. Further, if our economic crisis is in part a result of oil production decline then further economic contraction is inevitable then we must begin reorganize  and prepare for the new world-historical system (see Immanuel Wallerstein).

Im open to critiques, I am a Sociology grad-stsudent so my economics is a bit elementary, but that is the very reason I read this site, to learn. Redistribute the wealth (the financial sectors got it all)

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