Guest Post: Debunking The Keynesian Policy Framework: The Myth Of The Magic Pendulum

Tyler Durden's picture

Submitted by F.F.Wiley of Cyniconomics blog,

Way back in early March – before we witnessed new extremes in sloppy island bailouts and malicious economist witch hunts – I promised to “wield a ruler” and clear up some fallacies about the lengths of the things. The idea is that lengths are sometimes, well, exaggerated.

I discussed two length fallacies at that time, arguing that our fiscal challenges are more daunting than they’ve ever been, while proposing a debt threshold (imagine that!) beyond which countries struggle to restore fiscal discipline without default.

In this long-delayed third pass at the Length Fallacy Challenge, I’ll consider the third question – “How long is an ‘unassisted’ economic expansion?” I’ll choose an answer from the options on the right-hand side.

length match 4a

It may seem as though a question about economic expansions doesn’t belong in the challenge, since the other questions relate to our soaring government debt and other imbalances.  The connection is that varying business cycle perspectives can have huge effects on fiscal policy decisions, as I’ll explain conceptually and then demonstrate with data.

The policy approach that no one dares to question

Consider the following argument for fiscal stimulus (and I’ll get to expansion lengths in just a moment):

In the long-term, we need to fix our public finances. We’re on an unsustainable path that needs to be corrected to protect younger and future generations. But in the short-term, we need to focus on growth. The economy stinks and people are suffering. Any attempt to lower debt in these conditions would be folly. On the contrary, the government needs to provide more stimulus to promote growth.

This is surely not the first time you’ve heard this argument. We hear at least some variation whenever the discussion gets around to our national debt.

And it’s easy to see why.

The argument allows policymakers and pundits to show concern for both long-term finances and short-term difficulties. They can appear to be far-thinking and pro-active, strategic and tactical, responsible and compassionate, and all at the same time.

In other words, the argument appeals to anyone interested in popularity, and who doesn’t want to be popular?

But what about the general public? Why do we rarely challenge it?

I’ll suggest it’s because we tend to relate the economy to a single individual, typically ourselves. When the unemployment rate is high, we think about losing our jobs and the expectation that we would interrupt long-term financial plans while unemployed. After finding work again, we would expect to reinstate those plans. And it’s easy to imagine this logical mix of long-term goals and short-term tactics applying to the broad economy as well.

Alongside basic human nature, this way of thinking helps to explain why people always look to the government to make things right when the economy’s in the doldrums.  And the public’s calls for help make it easy to justify fiscal stimulus and delay action on the debt. Policymakers can follow the simple solution of paying lip service to the need for responsibility, and then saying how foolish it would be to get started today. Their stance is almost never questioned, especially as everyone says the same thing. Call it the Teflon Solution.

Pendulums and magic pendulums

Unfortunately, like all things that seem too good to be true, the Teflon Solution is flawed. To see this, we have to think about the economic scenario that needs to play out for it to work. The economy needs to reach its full employment ideal and then stay there, even after fiscal policies become restrictive in the effort to reduce debt.

But do economies just recover and stay recovered, in the same way that individuals regain employment and stay employed?

The Office of Management and Budget (OMB) says “yes.”  When it tells us about our public debt trajectory, its projections are based on a perpetual state of recession-free economic bliss.  The Congressional Budget Office also says “yes” (see OMB).  My answer is a big, fat “NO.”

Economies are inherently cyclical. Recoveries are helped along by the financial sector (through private credit expansion), external sector (think foreign capital) and/or public sector. And then bankers eventually overlend, businesses overinvest and/or consumers overspend, creating imbalances. When stimulus is replaced with restraint, the economy ends up back in the sickbed.

Think of it this way: When you push the economic pendulum forward with stimulus, you’re usually setting up a stronger move in the opposite direction once the stimulus runs its course. And this is the part that policymakers and economists ignore, deny or just plain lie about.

Economists, in particular, have built their most established theories on the idea that the economy isn’t a true pendulum but a Magic Pendulum. The Magic Pendulum of economic theory never swings back and forth. Instead, it always returns directly to its lowest point, where it remains still until disturbed by an external shock. At its lowest point, the labor force is fully employed.

With such an optimistic (delusional, really) perspective, it’s easy to see why so many economists support the Teflon Solution. If the economic pendulum were indeed magic, it would make more sense to wait for a full recovery before bothering with looming threats to government finances.

But in reality, this approach helps to explain our soaring debt.  It ensures that fiscal restraint occurs rarely and only for short periods of time.  When the economy recovers strongly enough that restraint is put into place, it tends to swing the real life (non-magic) pendulum back into recession, or at least slow growth. And at that point, political priorities revert back to the case for stimulus.

And sometimes the stimulus only needs to wear off for the real life pendulum to reach its turning point. Remember the idiotic tax rebate that Congress served up in Spring 2008? Many Keynesian economists argued that this little gift would push the economy right back to full employment and we’d continue on our merry way. But it was obvious to more realistic folks that spending would merely jump forward for a few months and then jump right back once take home pay reverted to pre-rebate levels. Sure enough, spending collapsed in the third quarter of 2008, and once again economists’ Magic Pendulum models blew up in their faces.

Keynesianism + Magic Pendulum = Teflon Solution

Okay, the sub-header’s dorky but all economics articles have formulas, right?  I’m just pointing out that the Teflon Solution is also rooted in an interventionist or Keynesian approach to fiscal policy.  It’s the combination of Keynesianism and the Magic Pendulum that leads to a chronic imbalance between stimulus and restraint.

But I’ll leave the more fundamental problems with Keynesianism for another day, and close by throwing some data at the Magic Pendulum.  As I said above, the Magic Pendulum holds that economies remain at full employment long after stimulus is removed.  I’ll show here that they don’t.

What does the data say?

I’ll work with figures from the table below, which contains America’s business cycle history according to the National Bureau of Economic Research (NBER).

lengths 3A

The table shows that the median length of an expansion is 30 months and the average is 39 months, which happens to be shorter than the current expansion by eight months and counting.

But I’m not interested in the average of all expansions. To test the Magic Pendulum, I’d like to know about the expansions that aren’t fueled by unusual stimulus.

More precisely, I’m looking for an answer to the question stated earlier:  How long is an “unassisted” economic expansion?

I’ll screen out the expansions that were prolonged by at least one of three different types of stimulus: war, deficit spending and external debt.

War. I’ll eliminate each expansion that occurred during major wars, defined as those that lasted at least three years and cost at least 1% of GDP in the peak spending year. There were six in total, including the Civil War, World War I, World War II, Korea, Vietnam and Iraq/Afghanistan. Wartime expansions tend to be longer than peacetime expansions and account for over half of the ten expansions that lasted longer than 39 months. And the length of the wartime expansions is, of course, explained by government spending.

Deficit spending. I’ll also eliminate the expansions during which federal debt grew at an average annual rate of more than 1% of GDP, measured from the year after an economic peak to the year of the next peak. In addition to four wartime expansions that met this criteria, the mid-1930s and 1980s expansions were also helped by large increases in government borrowing.  (And the current expansion will join this group once it ends.)

External debt. My third stimulus category is based on external debt, which clearly reached a saturation point at the end of the last decade’s housing boom. The most relevant figure is net external debt, calculated by subtracting U.S. holdings of foreign debt from foreign holdings of U.S. debt. When foreigners lend us more money than we lend them, domestic spending is boosted by the additional liquidity sloshing around the U.S. To determine which expansions benefited from rising external debt, I applied the same 1% of GDP threshold that I used for the other categories of stimulus. Each of the last three expansions exceeded the threshold.

I’ve summarized the results of my screen in the table and chart below. The table matches each type of stimulus to the expansions in which it lent a hand.

lengths 3B

And the chart compares the stimulus-assisted expansions to the other expansions in the data set.  It shows that nine of the ten longest expansions can be linked to at least one of the three types of stimulus. The remaining expansions help us to understand the characteristics of an unassisted business cycle.

lengths 3C

A tale of mortality and survival

The best way to interpret the chart is to calculate mortality and survival rates for expansions that weren’t assisted by any of the three types of stimulus, in the same way that actuaries construct mortality and survival rates for people. Here are the results:

lengths 3D

Consider first that we can’t establish meaningful mortality and survival rates for the first row in the table (12 months or less), for two reasons:

  1. Periods of growth that last only a few quarters are unlikely to meet the NBER’s criteria for an expansion. For example, the 1969-70 recession included two consecutive quarters of positive growth in the middle, but the NBER chose to embed that growth within a “double-dip” recession instead of declaring a short expansion.
  2. It usually takes about a year for the NBER to declare the beginning of a recovery. In fact, the time delay from troughs to the declaration of those troughs averages exactly 12 months since 1980.

Of the remaining twenty stimulus-free expansions, only 50% survived beyond 24 months. For those that did, the survival rate (the percentage of those lasting more than 24 months that continue beyond 36 months) dropped to 30%. Two of the three remaining expansions ended in their fourth year, implying a fourth year survival rate of 33%. And the fifth year survival rate was zero out of one, or 0%.

These calculations lead to a surprising conclusion: The odds of an unassisted expansion ending in any given year were at least 50%.

To say it again differently: In 150 years of business cycles, anyone expecting unassisted expansions to continue for another year would have been proven wrong at least half the time.

Even I didn’t expect the data to be quite that convincing.

The relevance of long-forgotten history

Now, many analysts would downplay the period between the Civil War and the Great Depression, which produced many of the stimulus-free expansions.  Moreover, we shouldn’t look just to the past to predict the future.

But we also know that the long expansions of recent times were skewed by a debt binge that’s been building for decades. And unless you’ve succumbed to the happy but insidious spell of the “debt doesn’t matter” school, you understand that debt can’t outgrow the economy forever. On the contrary, it eventually becomes far more of an economic problem than an economic stimulus.

In other words, recent history may be no more relevant to the future than the largely forgotten history of the late 1800s and early 1900s.

Getting back to the Teflon Solution, business cycle history lends no support to its key premise – the idea that the economy will return to full employment and stick there, allowing ample time for debt reduction. Once stimulus is removed, expansions often struggle to continue for much longer. And if the stimulus is replaced with restraint, it seems logical that the expansion’s expected life shortens further. In other words, there is no Magic Pendulum.

What’s the typical life of an unassisted expansion?

Based on the data presented here, I’ll call it two years.

length match 4


Charles Hugh Smith discussed “The Myth of a Self-Sustaining Recovery” in a post last month on his excellent site, OfTwoMinds, and on ZeroHedge.  His self-sustaining recovery is more or less the same thing as my magic pendulum.  Here’s the original article on the magic pendulum myth.

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Seasmoke's picture

Take away every public pension. Let everyone keep their house mortgage free, they have been paid for.

SKY85hawk's picture

I paid off my mortgage in 2009.  What do I get?

THE DORK OF CORK's picture

Well the neo keynesians are closer to the greenbackers (although not quite all there yet)


Anyway its better to have state fiat in a system rather then free banks producing credit with the stamp of the state on it which is the worst of all worlds.


There is no "natural growth" or "business cycle"


The business cycle is infact the free banks extracting capital from the system via the credit process.


See 8.30 "how long does it take for debt to double"

The interaction of debt with the physical economy.

max2205's picture

Turn up the power in them levitating electo magnets!

Element's picture

It doesn't fail because it's such a bad idea, per-sec.

Keynesianism fails because they want to spend in the high revenue times.

And then spend even more-so when revenue is in the toilet.


oh, ... wait ... I think I may have this confused with govern-mental-ism ...


PS: a good article though

THE DORK OF CORK's picture

"Economies are inherently cyclical. Recoveries are helped along by the financial sector (through private credit expansion), external sector (think foreign capital) and/or public sector. And then bankers eventually overlend, businesses overinvest and/or consumers overspend, creating imbalances. When stimulus is replaced with restraint, the economy ends up back in the sickbed."



Even under gold standard systems non imperial currencies have internal sov power so that all debt hyperinflated (or overlent.............I like that) can be repaid and assets cannot be stolen by the the people who create private credit.

THE DORK OF CORK's picture


Private credit providers of both interest bearing fiat and consumer credit have taken people out of the physical economy through the process of unemployment.


The very act of claiming back debt that cannot be repaid impacts on the total real physical output of the economy.


Don't mix up the debt with the token (equity) money supply of a country

Don't ever  let any bank fuck with the money supply of a country creating inflation or deflation extractive events.

Fuku Ben's picture

Columbia Economist Dr. Jeffrey Sachs speaks candidly on monetary reform




johny2's picture

the rats are the new lamb.

hooligan2009's picture

ah yes...but did unsupported expansions fail after two years because of government actions?

still seems to me that 150% government debt to GDP is just as wrong 90% government debt to GDP 

as a basic financial tenet...if your interest on debt (at whatever rate) is greater than the amount of discretionary spending..the nation state has failed...because non-discretionary spending IS DEBT.

non-discretionary debt is a variable; falling unemployment can reduce this debt and increase discretionary spending.

welfare numbers are not included in the analysis..previous posts here show that a smart benefit claimer can make the same amount of money as a dumb 68,000 gross earner..that is a big problem...similarly a country can #"afford" a lot more debt at a 1.7% ten year bond yield than a 5% ten year bond yield.. in the case of the 16.7 trillion of US debt.this extra 3.3% interest yield equates to over 500 billion per annum..if interest rates were ever to increase to "normal and fair" levels for risk and inflation.

federal budget has tax receipts of 2.5 trillion (15% of gdp) and spending of 3.5 trillion (21% of gdp)..including debt interest of c. 580 billion at historic borrowing costs of c. 3.5%..discretionary spending is carded in budgets at c. 10% so 350 billion out of 3.5 trillion.

ergo, 3.15 trillion of spending is non-discretionary and the structural deficit is 650 billion at current rates of interest..

debt is 107% of gdp will grow at 650 billion (4% of GDP) plus any increase in the interest rate on debt.

the fed is making fresh deficit government debt interest free (substiution of bank notes for bonds) so is reducing the 3.8% cost to government for incremental debt...but not old debt..old debt is pre-qe..qe is 2 trillion of government debt, so 14.7 trillion is "at risk" to rising interest rates...

bottom line..the US is operating at a 4% of GDP structural deficit..before state and local budgets are taken into account.

spending needs to drop by at least 650 billion out of 3.5 c. 20%..

it seems likely to me that any revenues resulting from employment improvement will be completely absorbed by yield increases on government debt...unless the Fed completely replaces government bonds (say ten year life with a return to normal 5% yield) with fed paper (zero coupon perpetual)..

we need better mattresses and to withdraw all cash from banks..forthwith

hooligan2009's picture

for reference

check out state and local government spending and the total debt

Aquarius's picture

The Problem is:

Simply put: Politics

We need to reinvent our social structure;

We need to dump "Economics" as it is nothing but a religous Cult which exists to support political experiency; opinion at best.

We need a system that allows for the full range of human behaviours of man - that cannot be captured by collectives.,

We need to instil Morality and Ethics into our behavioural code,

We need to return to confront reality,

We need to live in Risk

Today, the World's focus is on the political saviours (sarc/off) and the Economist Gods.

The USA is in a free-fall collapse and demands the World follows:

Time to grow up Grasshoppers, or soon you will be=come consumptive stew.

Ho hum

hooligan2009's picture

i agree..but maybe..just maybe,.since the government is the people..people are getting what they want..whether that is failure and collapse or getting back more than they put in to the pot.

Aquarius's picture

Respectfully, I posit that the government is not the people; it is groups of powerful people in collectives that live in corruption to recursively scam those that are not as fortunate or as wealthy as themselves. Those who govern; those that are "leaders' carry a responsibility to those that are governed. You do not find this anywhere on this planet today, except perhaps in Singapore. Government is no less that a protection racket run by gangsters in fine suits that talk "superior" nonsense to hide the fact that they are a collective comprised of consensual ignorance maintaining a system of theft and improprietry. As @RM states a murder diktat (my words).

And it is founded by the so-called "intellectual" imbeciles that believe that their knowledge comes out of the genius of the ancient Greek Philosophers - that justifies their creation of ideologies of fantasy in their names. What crap! None of these moron have studied the earliest Greek, Roman or other Philosophers of those early days otherwise they would have realized that the earliest Philosophies were already long established by the early  Egyptian Sages of pre-Circa 2400 BCE periods and their knowledge was merely plagiarized by the Greeks in the first instant and by all others that followed. An Example of the ideologically driven morons founded in the Greek is that of Heraclitus who stated that "Everything is in a state of flux". If this is so, how then can one justify "statism", the "status quo" or ideology?

No, the morons on high desire rule (their) by a system of the dead - statism, and develop "ideologies for the dead; the unanimated yet life continues in its dynamic state of flux; this is the realm of the living.

"Let the dead bury the dead". Corpus Hermetica - says it all really. And, you will find all these dead in Plato's Cave grouped at the rear and darkest places shivering in fear and eating their fellow man.

Ho hum 


GoNavy's picture

The dirty little secret is that the current fake "expansion" is almost completely burned out.  (Just in time for Joe Mainstreet to get back into the market and get the crap kicked out of his "Dow 15,000!" shitty little 401(k) that he rolled over when he got shit-canned from his last real job so he could start his new career as a Wal*Mart greeter.)

Your [insert uber-brokerage firm name here] financial "advisor" will be right with you to fuck you very much.

Vidar's picture

This article displays a lack of understanding of what the business cycle really is. The recession/depression is the necessary correction of the credit-expansion created boom or expansion. You can't have one without the other, and both are a result of fiat money and/or fractional reserve banking. A truly capitalist economy, with honest banking and commodity money (and zero government involvement in the economy) would not have business cycles. It would have fluctuations and periods of more or less rapid expansion and contraction, but not the regular ups and downs that characterize the "business cycle" as it is commonly understood. The best book to understand all of this is Rothbard's "Americas Great Depression", available free at the Mises Institute.

W T F II's picture

We are past the 50% point in the turn upwards on the parabolic-shaped curve, which graphically depicts the exponential function.

That is ALL anyone needs to know and it isn't GOOD...!!

That sucker WILL go to infinity in nano-seconds...CASE CLOSED..."Next 'system' please..!!"

dunce's picture

Every time there is a problem, the people in govt. think they must "do something". Whatever they decide to do is nearly always wrong and makes things worse or has a short term positive effect followed by a long term problem that they do not perceive was caused by the previous action so they implement another wrong action to fix it. They never stop digging the hole deeper.