The evidence for Keynesian economics

by Russ Roberts on October 11, 2011

in Stimulus, Uncategorized

Paul Krugman explains why he believes (his verb) in Keynesian economics.

A correspondent asks a good question: what evidence makes me believe that Keynesian economics is broadly right, given the relative absence of experience with large fiscal stimulus programs?

I’d answer that question with several points.

First, we’re talking about a model, not just a prediction about the impact of spending increases. So you can ask about the ancillary predictions of that model as opposed to rival models. Anti-Keynesians assured us that budget deficits would send interest rates soaring; Keynesian analysis said they’d stay low as long as the economy remained far from full employment. Guess who was right?

Krugman is a superb polemicist. He takes a single argument of anti-Keynesians and uses it to show us that Keynesian claims beyond the effects of stimulus spending are probably right. Does Krugman really believe that you can’t have high interest rates when there is high unemployment. The stagflation of the 1970s when there was high unemployment with high interest rates is one reason Keynesian went into disrepute.

Also, there are some features of the approach that can be tested separately. Keynesianism isn’t just about sticky prices, but it does generally assume sticky prices — and there is overwhelming evidence, from a variety of sources, that prices are indeed sticky.

This is an even better piece of polemicism than the first one. Keynesian models assume sticky prices, prices are sticky, therefore? Therefore what? Therefore Keynesian models have somewhat realistic assumptions. That isn’t the most convincing selling point.

Also also: there’s plenty of evidence that monetary policy can move output and employment — and it’s very hard to devise a model in which that is true that doesn’t also say that fiscal policy can be effective, especially when you’re up against the zero lower bound.

Yes, there is plenty of evidence that monetary policy can have real effects. So why isn’t there plenty of evidence of fiscal policy having real effects? He has to say that in the models (whose? which ones? All of them?) that presume monetary policy works, so does fiscal policy.

So his first point is that the model works well–it has correct implications in general, its assumptions (well one of them anyway) are realistic and if monetary policy works, fiscal policy should too.

Second, while we don’t have a lot of postwar experience with fiscal stimulus, we do have a lot of experience with anti-stimulus, that is, austerity — and that turns out to be reliably contractionary. Again, it’s hard to think of a model in which austerity is contractionary but stimulus isn’t expansionary.

Finally, there is evidence from fiscal expansions in the 1930s, which actually did lead to economic expansion too.

Mainly I’d stress the first point. We have a model of the way the world works, and the world does indeed seem to work that way. And an implication of that model is that fiscal stimulus will work under conditions like those we face now. If interest rates had soared, if the rise in base money had led to rising GDP and/or soaring prices despite the zero lower bound, I would have sat down to reconsider what I thought I knew about macroeconomics. In fact, however, my preferred model has passed the test of events with flying colors, while the other guys’ models have been totally wrong.

If I were defending Keynesian economics I guess I’d go with the first point, too. Because the empirical evidence he cites in his second point is very mixed. Krugman cites the studies that supports his view (as we all tend to do.) He leaves out the post-WW II expansion that followed huge cuts in government spending where the Keynesian predictions were totally wrong. He leaves out the stagflation of the 1970s. He leaves out all the studies that find a small multiplier (Barro and Redick, Ramey (who will be a guest on EconTalk in the next two weeks) and work by Alesina that shows that contractions in government spending (the austerity Krugman refers to) actually encourage economic growth.

The evidence for the Keynesian worldview is very mixed. Most economists come down in favor or against it because of their prior ideological beliefs. Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government. Both of us can find evidence for our worldviews. Whose evidence is better? I’m not sure it’s a meaningful question. My empirical points about Keynesianism won’t convince Krugman. His point don’t convince me. I am not saying that we will never get any kind of decisive evidence on the question. I’m saying it sure isn’t here now.

UPDATE: Krugman defends himself here.

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Gary Irwin October 11, 2011 at 11:42 pm

Didn’t the Japanese government, after their commercial real estate bubble crashed, attempt for many years to restart their economy using Keynesian stimulus. I believe they concentrated spending on infrastructure, and the economy didn’t react at all to it. If this is correct, I would like to hear the proprietors of Cafe Hayek to comment on it.

ConnGator October 12, 2011 at 8:16 am

There was an interview with the foremost expert on Japanese policy that said the reason for the “lost decade” was actually too little stimulus. And he warned the US not to make the same mistake.

I think that is poppycock, but it is out there.

Josh October 12, 2011 at 12:02 am

“Whose evidence is better? I’m not sure it’s a meaningful question.”

That is exactly the right question and answer because if you have to ask that question then NONE of the evidence is good. (And every macro person has to ask that question.)

joe October 12, 2011 at 12:05 am

It doesn’t surprise me that Keynes made some observations; he was a brilliant man and maybe wages are sticky, maybe how people just “feel” does affect things (the animal spirits.) But it’s a grand leap from these simple observations to the sweeping theory that when “the economy” is in the dumps, government should “make people spend” at gunpoint.

Isn’t that what stimulus is, in a nutshell? People aren’t “spending enough” they are “holding onto cash” or are actually poor and don’t have much cash, so there is this “lack of demand.” If only we could fix that?! Let’s think. I’ve got it – we can simply send men with guns to everyone’s home and order them to “spend, darnit, spend!”

Ok, so that’s not exactly how Keynesian stimulus works but almost. Instead of directly sending men with guns to each home, in our civilized society these monies are simply collected in taxes and spent for the people – thus “creating demand?”

I thought of this when they were doing the TARP program. There were all these worthless or nearly worthless assets the banks were holding. I sure didn’t want them. No one else did, the banks didn’t want them. So what the govt did was in effect exactly the same as sending men with guns to every person and telling them “each person shall purchase $2,000 worth of these worthless assets.” Except it was done though taxation.

Now the heart of Keynesian stimulus is exactly that – when people don’t “feel like” spending money you simply put a gun to their head and make them. Does it work? (I donno, maybe for a short time?) But is that the way to prosperity? Is that how free men should live or can live? When do we ever know when we’re “spending enough?” How would the gov’t know when we’re spending “enough?” By what means of measurement?

I heard Higgs once simplify it: There’s two ways for human beings to interact with each other – either by force or by voluntary cooperation. And at it’s heart, Keynesian-ism is about using force to make human beings do things against their will (make them spend, make them borrow, etc). And the free market is voluntary cooperation.

I’ll take the free market in any case. I do believe the free market also results in wealth, more than planned economies but even if it didn’t, I’d still take freedom over Keynesian control.

GiT October 12, 2011 at 1:59 am

That’s not a very accurate parody of Keynesianism.

And it’s a rather trite and boring parody of taxation.

PrometheeFeu October 12, 2011 at 1:54 pm

Do you disagree with the analogy for taxation or do you just think it has been repeated too many times?

GiT October 13, 2011 at 5:47 am

No, I do not think taxation is theft, and I think all the histrionics that it is are rather ridiculous.

joe October 12, 2011 at 2:20 pm

I plead guilty to being boring. I wasn’t very concise.

I could have just said I don’t care if Keynesian-ism is right or wrong; I just don’t want to live under tyranny, I want to be free.

That’s a hell of a bias – but I still think the free market is more prosperous. Almost no one argues that govt involvement in the economy is to “improve the economy” – even they admit it’s to “punish the guilty” or “punish excesses or to curb greed” or some such thing.

billyblog October 12, 2011 at 7:38 pm

Relax, Joe. We’re not after your precious bodily fluids.

Take a deep breath and reflect on the fact that your “intellectual” presentations are freighted with metaphors of violence from start to finish.

You would say that it’s because “they” really are out to rob you of your freedom — at gunpoint no less. And “they” are, of course, immoral to boot (see Andrew’s comment). Heck, maybe even unpatriotic.

I would say: try to remember to take your meds, Joe.

joe October 12, 2011 at 8:22 pm

Thank you. Although I’d say my precious bodily fluids (Purity of Essence) is the only thing they aren’t after.

GiT October 13, 2011 at 5:50 am

No, they don’t ‘admit’ that. They don’t ‘say’ it either.

The usual justification for government taxation usually relates to public welfare, the common good, and so on.

No reason to equivocate and generate your own strawmen about government being based on a desire to punish people for their success, which is a paranoid fantasy, not an argument you’ll find anyone making.

Andrew_M_Garland October 12, 2011 at 4:41 pm

To Joe, in support.

Here is a view of the Stimulus Plan from the bottom up. Ivy league elites are determined to increase accounting measures, whether you like it or not.

Consuming only has value if someone wants to do it, and wants it now rather than as savings in the future. When you take money from people to spend now, you are disrupting their wealth and freedom just as if you had pointed a gun at them and told them what to do.

Borrowing the money as public debt is an immoral loophole. The people who create jobs and plan for the future know that the government is going to force them later to pay it back. Or worse, the economy will collapse and no one will be able to pay, and everyone will pay in fewer jobs, lower salaries, and a dismal outlook. We see this now as a result of past forced transfers, such as with housing loans.

The Department of GDP
You can spend, or government will do it for you. You owe it to us all to increase GDP.

=== ===
Official: Good. (flips through manila folder) Now, I see that you don’t go to restaurants enough. Why is that?

Joe: My wife is a great cook. We eat at home most of the time. I even like cooking with her sometimes, and the kids help too.

Official: Yes, that comes up a lot. People are denying themselves the pleasures of fine dining. You can see how this decreases employment and GDP. From now on, you will dine out at least twice per week, with the kids please.
=== ===

Michael October 13, 2011 at 11:49 am

Every time I hear that argument from libertarians about not wanting government to tell us what to do as a kind of absolute, I get the impression that there is a basic adolescent immaturity at the heart of that ideology. It is like a kid who just hates school rules. There is no understanding that some rules are probably better for the functioning of the community and some probably aren’t and consequently no insight into why or how just hate for the idea of mutual dependence that forms a community. It’s the flip side of authoritarian fetishing of rules and hierarchy and no better. So it’s ultimately intellectually lazy as well as immature.

Andrew_M_Garland October 13, 2011 at 12:45 pm

Maybe you could be more specific.

Possibly you support government borrowing “for the good of us all”. Do you also support that all of us should pay back that borrowing, say in proportion to our incomes? If it benifits “everyone”, shouldn’t everyone pay it back?

river c October 13, 2011 at 9:47 pm

“I do believe the free market also results in wealth, more than planned economies…”
Agreed…but the most important truth is that wealth requires theft, whether it is land, resources, unfair labor practices, or in the case of the future or for many on the planet right now, a stable, predictable enjoyable life.

Growth for the sake of growth is the philosophy of the cancer cell. A world where products from half a world away, with many steps and middlemen benefiting in between end up in an empty but still open 24 hours store for the low low price of a dollar is anything but efficient. A world where a McDonalds meal is cheaper than fresh, healthy food is a diseased one.

“Dear future generations: Please accept our apologies. We were rolling drunk on petroleum.” Kurt Vonnegut

river c October 13, 2011 at 9:49 pm

his is to add to the conversation. I am a guilty of this theft as anyone except our economic, governmental and military leaders, who are awash in responsibility beyond measure.

Justin P October 12, 2011 at 12:27 am

Excited towards Ramey will be a guest soon. I hope you go into detail on the methodology of calculating multipliers.

Justin October 12, 2011 at 12:47 am

I don’t get how Keynesians can point to interest rates and say “see their not rising” when the Fed is doing all it can to keep them that way.

Chucklehead October 12, 2011 at 1:13 am

Exactly right. Fed QE policy buys the majority of treasuries to distort the interest rate. At the same time , treasury understates inflation (except food and fuel, who has money for anything other than food and fuel.) The end result is a tax on savings especially the principle. This further discourages capital formulation and adds to the malaise.

geoih October 12, 2011 at 6:58 am

It’s the same with the GDP numbers. If the state spends trillions of dollars, the GDP goes up. It’s call arithmetic. When the spending stops, the GDP goes back down (you know, subtraction). The idea that this is growth is ridiculous.

anthonyl October 12, 2011 at 9:03 am

Thanks for making that super simple but powereful point.
Now why don’t others see it?

Chris Bowyer October 12, 2011 at 12:01 pm

It’s like teaching to the test. They use the fact that GDP generally indicates growth and assume that anything which increases GDP must mean real growth. It’s like trying to move the needle rather than actually accomplish the thing that the needle’s measuring. You might as well put your car (a favorite economic metaphor of the Obama administration) up on the blocks, put your foot on the gas, and say you’re speeding alone because the speedometer’s at 60.

Fred October 12, 2011 at 12:06 pm

Since anything the government spends in the economy must first be removed from the economy, I would think G should be zero.

RM October 12, 2011 at 9:13 am

I was going to make this point, but in more detail. The concept that government stimulus is providing any value at all is entirely predicated on the Fed buying back debt from banks which purchase it. And the agreement is such that the banks see a tidy profit for selling that debt to the Fed.
At what point will Krugman (or these authors) discuss the Mississippi Bubble and the effects of issuing newly printed money in exchange for a presumed valuable object (public debt), in an attempt to keep economic activity at a certain level?
Clearly inflation is everywhere (regardless if you focus on energy, food, or ShadowStats – all you have to do is ask “are we in a deflationary environment?” The answer is yes. So where is the deflation? Nowhere because even low inflation in a deflationary environment is a form of massive inflation). We have created a situation where the illusion of price stability is causing people to spend into a debt driven recession, further exacerbating the problems which have led us here. The Keynesian model assumes an inverse relationship between Investment and Savings. At this point, the only investment that can occur would be derived from Savings – so how can they possibly be at cross purposes? The distortions Fed policy is causing act as a buffer for Krugman’s lame argument.

Ryan Vann October 13, 2011 at 4:22 am

“The answer is yes. So where is the deflation? Nowhere because even low inflation in a deflationary environment is a form of massive inflation”

That might be the most profound statement I’ve read about the current scenario, and I think it is 100% spot on. Incredible point.

m October 15, 2011 at 2:18 am

Do you mean geographically or which goods? Which goods is easy: our single largest expense has fallen (and is falling) dramatically: housing. Housing prices are down and mortgage rates are also down. We’ve also seen falling prices in most electronics: laptops have fallen by half 30-40% since the depression started. Smart phones are now free, and tvs are far far cheaper

My cable bill is 14% cheaper than 2008. When I replace my Mini next year, I’ll be able to get a Fiat for $4k less with the same features. Heck, the local even serves beer for under $6 again.

Seth October 12, 2011 at 1:08 am

So, Krugman believes in broken clock because it is more accurate at times than a clock that is persistently off by a few minutes? Wow.

Chucklehead October 12, 2011 at 2:35 am

Bingo

Methinks1776 October 12, 2011 at 8:18 am

Nice.

Henri Hein October 12, 2011 at 1:56 am

One big problem I have with Krugman’s line of defense is: the idea of model is flawed altogether. It is impossible to model something as complex as a modern economy. If 1,000 people each make an economically significant decision with two possible choices, there are 10 to the power of 300 combinations. That is just a single day in a small town. I don’t see how they think they can model 300 million people in a $14 trillion economy.

Methinks1776 October 12, 2011 at 8:18 am

The persistent problem of central planning.

Daniel Kuehn October 12, 2011 at 9:52 am

What you mean, I think, is that it is impossible to reproduce all the elements of a complex system with complete fidelity. That is certainly true. But it’s clearly possible to model mechanisms in a complex system, and to model them with less than complete fidelity. We do that with other complex systems all the time, and we do it successfully with economies too.

Complexity prevents us from generating complete and deterministic models. That’s why central planning doesn’t work (as Methinks points out above). We should not confuse that with making models of specific mechanisms or processes to help us understand the economy better. We can do that just fine.

Jim October 12, 2011 at 11:15 am

Actually we do not model the economy well. The Fed couldn’t even tell it was inflating a bubble, and denied the severity of a recession that virtually anyone with common sense could tell you was going to be nasty.

And I defy anyone to compare the 1930s economy with significant agriculture vs GDP, mountains less public and private debt, no derivatives, etc. with today’s society where an unemployed person can not even start a barbershop and business is leaving in droves because of land and employee liability. And yet economists do it all the time. There is no regression that accounts for the complexity changes.

Heck, economists compare Sweden or Greece to USA. They are about the size of Miami and half as diverse.

It is a problem not isolated by economics. I read a great number of academic research papers, and most of them are not worth the paper they are written on.

Phil October 13, 2011 at 10:37 am

we had mountains less public and private debt in total. but we also had mountains less GDP and wealth. after WWII, we had much higher mountains of debts compared to GDP.

Super Fly October 12, 2011 at 2:56 am

I had the same question as Justin (no ‘P’) when I first read Krugman’s piece. What role does the Fed play in this picture according to Keynes and/or Krugman? I thought they kept interest rates low, but I can’t imagine that Krugman (despite his spotty track record) would omit something that big.

Peter October 12, 2011 at 4:18 am

If Christians had as much faith in the Bible as Keynesians do in their models, the world would be a better place.

geoih October 12, 2011 at 6:59 am

As long as you’re a Christian.

PeterI October 12, 2011 at 7:58 am

If both Christians and Keynesians (as welll as followers of other belief systems/schools of thought) were a little bit more sceptical the world would be a better place.

A. Zarkov October 12, 2011 at 5:23 am

In physics anyone making the kind of arguments that Krugman makes would get laughed out of the room. Even outside of physics, in (say) systems ecology, Krugman-type arguments would come across as extremely inadequate. Krugman clings to Keynesian theory with a kind of religious devotion that should embarrass him. Once a counter factual appears, a theory needs to get either modified or abandoned. After all we had to modify Newtonian mechanics with General Relativity to explain the precession of apsides of planetary orbits, gravitational red shift, the deflection of light paths near the sun and many other observables. Without General Relativity, we could not design a working Global Positioning system. So far General Relativity predicts everything we observe, but cannot be reconciled with quantum mechanics giving rise to research in string, and other unifying theories. On the other hand, economics seems like it’s spinning its wheels. First Keynes was the dominant theory in the 1950s and 1960s, only to get abandoned in the 1970s, and then reanimated after 2007. If Krugman and other maco economists want us to believe that stimulus spending works, they need to come up with a theory that at the very least explains what we have observed in the past and what we now observe. Romer predicted that ARRA would lower unemployment– it didn’t. It should have least gone down somewhat with a $850 billion input. In fact the zero-input scenario comes closer to reality. The theory is wrong. Before we spend even more of the public’s money we should at least have a new or modified form of Keynes that at least looks like it will work.

Justin P October 12, 2011 at 8:21 am

I agree but your holding econ up as a predictive science. It isn’t.

RM October 12, 2011 at 9:15 am

True. But it can be, in certain circumstances. As my father (a doctor) says, “Science is about explaining why things happen. The predictive nature of it is a byproduct.”

Jim October 12, 2011 at 11:18 am

IF it is not a predictive science, then it should stop informing stimulus policy and the Fed should stop controlling interest rates.

BW October 12, 2011 at 9:16 pm

You are heavily uninformed about Keynesian economics and about the empirical evidence that exists in its favor.

Think about what you are doing here. You are comparing a *blog post* by Paul Krugman with a formalized scientific theory developed over 30 years.

The ARRA did decrease unemployment. The empirical studies — with which you are surely unfamiliar — show that. But it worked in the real world, not the world of original projections. As it turned out, the magnitude of the unemployment problem was not fully realized in Feb. 09 — indeed, only recently have economists come to realize how deep the recession had been. So the problem was worse than thought, and the effectiveness of the cure meant only that the status quo was maintained (as opposed to continued deterioration).

There was also, as you may know, a massive deleveraging at the local and state level. Extremely contractionary fiscal policy. That neutered much of the effect of the ARRA, which is why overall we haven’t seen the anticipated improvement. But the timing of the policies were not perfectly coincidental — which is why there was clear evidence of the economy beginning to grow when the ARRA kicked in, and then clear evidence of backsliding as the contractionary state policies kicked in.

Economiser October 13, 2011 at 10:45 am

> As it turned out, the magnitude of the unemployment problem was not fully realized in Feb. 09 — indeed, only recently have economists come to realize how deep the recession had been.

Good job moving the goalposts after the fact. Your prediction is nonfalsifiable: it’s not science, it’s scientism.

Lionel from France October 12, 2011 at 6:00 am

For me, It’s just a matter of logic. Keynes’s analysis is wrong on very fundamental points. The negative consequences of Keynesian policies have been widely established theoretically and empirically verified. Just read (and reread) the Classics and Keynes to see clearly the mistakes of Keynes.

muirgeo October 12, 2011 at 6:10 am

I think we are seeing the results of fiscal policy happening real time. During the stimulus spending we saw, both here and in Britton, increases in GDP and employment as soon as that spending dried up and pushes for austerity were made we saw and are seeing the reverse. In Greece, Ireland and others that went full bore into austerty the results have been poor. Germany and China went heavy with stimulus and have seen great results.

It appears to me that the anti-Keynesians have their backs to the wall. More austerity is going to lead to more contraction and we will NOT apparently see massive improvements in our economy short of some major reversals of policy that got us here.

The big picture fits one of decreasing demand related to decreased wages related to forcing our workers to compete against 3rd world workers. And most important is to realize these changes are and were policiy driven just as they were in the past.

My big theme is policy matters… so you better have your policy makng apparatus intact.. we don’t as it is owned by monied interest and that is all of the problem.

We saw similiar policy trends leading us into the Great depression and to this one and we saw what policies got us out of the Great Depression. The consistency inspite of the history revisionist is impressive to me.

IMF has a good study which suggest THEY should maybe reconsider their own practices on austerity.

http://www.imf.org/external/pubs/ft/fandd/2011/09/Ball.htm

geoih October 12, 2011 at 7:11 am

Quote from muirgeo: “My big theme is policy matters… so you better have your policy makng apparatus intact.. we don’t as it is owned by monied interest and that is all of the problem.”

The Keynesians and the monied interests are the same people. It has nothing to do with economics. It’s all about politics.

If your policies are being set by ‘economic’ models that don’t work, then you’re policies won’t work either, unless of course your goal is only to secure political power.

muirgeo October 12, 2011 at 8:02 am

“The Keynesians and the monied interests are the same people.”

That’s not true. The monied interest and their lobbyist are NOT pushing for Keynsian policies. Not even Keynsian policies but just effecient policies.

For instance…. the monied intersts are NOT in favor of the current bill to address China’s currency manipulation because their factories are NOW in China and it will hurt them even though it will improve our exports. They are not exporters… they are importers because their factories are in China.

Ghengis Khak October 12, 2011 at 4:40 pm

Is it the case that Keynes(ians) are generally in favor of protectionism? It is my understanding that the two aren’t necessarily connected in a fundamental way.

Ghengis Khak October 12, 2011 at 4:32 pm

“During the stimulus spending we saw, both here and in Britton, increases in GDP and employment as soon as that spending dried up and pushes for austerity were made we saw and are seeing the reverse”

Increasing G can increase GDP. Borrowing money to pay people to do things decreases unemployment. Unrolling these things undoes the short-term effects they had because they are wasteful and unsustainable. Is any of this supposed to show that something good resulted from the stimulus (other than funneling a bunch of money to interest groups that you vote with)?

Spending per country for 2009, 2010, 2011 (in billions). Please be so kind as to point out the austerity.
UK: 671, 697, 711
US: 3100, 3600, 3800

Emil October 12, 2011 at 6:33 am

The real problem with Keynesianism (and where it all falls apart) is not what to do in a crisis but what to do when the economy is doing fine. Keynesianism is contra-cyclical both when things are going fine and when they are not. It thus foresees budget surpluses when the economy is doing fine. We know empirically that elected politicians are notoriously incapable of cutting spend and/or increasing taxes when the economy is doing fine. This is why Keynesianism doesn’t work.

muirgeo October 12, 2011 at 8:09 am

You equate a failure of policitcs to a failure of Keynesianism.

Isn’t that like saying libertarianism will fail because politicians will not adopt it’s policies properly.

The more I read about Keynes the more I understand he was a supporter of markets and capitalism and no bleeding heart liberal. He was if nothing else a pragmatist but indeed an elitist.

Emil October 12, 2011 at 9:00 am

As I said below: there is consistency in libertarianism in that big government is bad. There is no consistency in Keynesianism which claims that government should act in a certain way under a very specific set of circumstances while glossing over that it is a requirement for the success of their policies that the same government acts in another way under a different set of circumstances.

All I’m trying to say is that you can’t judge the success of Keynesianism only on its effects in one part of the cycle as an integral part of the theory is what is done in the other part of the cycle. Alas, you don’t need to prove that Keynesianism is not successful in the short run to prove that it is not successful in the mid to long term.

Ghengis Khak October 12, 2011 at 4:44 pm

I think what Emil is trying to say is that a state powerful enough to engage in strongly Keynesian policies during one part of the cycle is, in a very deep way, inconsistent with a state that will let markets forces reign during the other part of the cycle.

In other words — there is no way to have both of these things, even for those (some subset of Keynesians) who want them.

Emil October 13, 2011 at 3:46 am

Actually, not really. I don’t think that Keynesianism actually says that the market forces should reign during the other part of the cycle (although I might be wrong), what it does say is that there should be (government) account surpluses sufficient to pay down the debt incurred during the downturns.

What I am trying to say is that even if there were evidence that Keynesianism works during recessions that is not sufficient as that would only prove 50% of the theory.

Greg G October 12, 2011 at 6:46 am

Yes, many who called themselves Keynesians predicted we would need continuing fiscal stimulus after WWII. But I don’t believe Keynes ever did. Can anyone show me where he did?

I read Keynes as advocating a counter-cyclical fiscal policy. That seems like common sense to me. Counter-cyclical cannot mean unending deficits. The boom after the war is evidence for Keynes, not against him.

Greg G October 12, 2011 at 6:55 am

Emil, I dropped my comment in reaction to Russ without reading the others. I agree with you completely but I am saying: Let’s not call a failure to actually try what Keynes advocated a failure of Keynesianism. This blog is often all about advocating ideas (Libertarian ones) in a purer form than have been tried before.

Emil October 12, 2011 at 6:57 am

No, it is evidence against Keynes because he is advocating something that is not possible under the current political system, alas he can be as theoretically right as he wants to but his premises are not those of the world we live in.

Greg G October 12, 2011 at 7:38 am

Emil. Don’t Libertarians have exactly that same problem then?

Emil October 12, 2011 at 7:54 am

maybe yes to a certain extent but at least we are consistent about what the problem is.

Keynesianists are instead inconsistent in that they propose more government despite that same government being the problem.

Greg G October 12, 2011 at 8:55 am

Emil, It is true as, as you say, that the implementation of truly and consistently counter cyclical fiscal policy is “not possible under the current political system.” But there was a time when it was possible. That would be from 1941 to around 1965. And it worked amazingly well then. We pulled the economy out of the depression with borrowing and then paid that debt down steadily in a time of prosperity.

Is there some historical period I am missing where Libertarian policies were implemented with comparable success? It was Reagan, not Keynes that convinced the neocons that “deficits don’t matter.”

Emil October 12, 2011 at 9:06 am

“Emil, It is true as, as you say, that the implementation of truly and consistently counter cyclical fiscal policy is “not possible under the current political system.””

Ok, so you agree with me that Krugman is in the wrong then. Good

“That would be from 1941 to around 1965.”

If I’m not mistaken there were also one or two other things going on in that period that may sort of have influenced the results somewhat…

“Is there some historical period I am missing where Libertarian policies were implemented with comparable success?”

Full-blown libertarianism no, but several countries have implemented large parts of libertarianism with considerable short and long term success:
- the UK under Tatcher
- Hongkong
- the US in the 19th century
- Chile

Furthermore, the list of countries in which the economy has improved with also small steps from being very non-libertarian towards being more libertarian (or less statist) is by no means short.

kyle8 October 12, 2011 at 6:46 am

I am not sure you are correct about the lack of empirical evidence. Didn’t Japan enter into a massive decade and a half experiment in fiscal stimulus?

And are they not still in the economic trash heap?

Also, there is our own recent experience.

James N October 12, 2011 at 8:01 am

“Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government. Both of us can find evidence for our worldviews. Whose evidence is better?”

I don’t believe the answer is relevant, because you’ve already gained the moral victory. Even if we assume that there’s no way to determine which system is “better”, for the economy, we know which one is immoral.

Pierm October 12, 2011 at 8:11 pm

Krugman wants the government to accomplish certain goals to improve the lives of the middle class and poor. He is totally indifferent with regard to the size of the government. If a small government could accomplish those goals then he would be happy with that.

Methinks1776 October 12, 2011 at 8:11 am

He leaves out all the studies that find a small multiplier (Barro and Redick, Ramey….

Didn’t Barro find the multiplier is negative?

Justin P October 12, 2011 at 8:23 am

I think he did.

jjoxman October 12, 2011 at 8:47 am

Barro also find the multiplier of individual companies (General Electric, I think) to be high and positive.

Fred October 12, 2011 at 8:52 am

It’s only common sense that if you remove money from the economy through taxation and borrowing, pay government employees to produce nothing of value, then hand out this reduced amount of money based upon political considerations, that the result will be worse than if the money was never removed from the economy in the first place.

Methinks1776 October 12, 2011 at 9:29 am

Yes, it does, Fred. But, I’m not sure that the multiplier would be positive if the money were spent in the impossible way Keynes envisioned.

Fred October 12, 2011 at 10:26 am

It defies common sense to say that removing x dollars from the economy and putting x – y dollars back in will have a multiplier effect.

It takes a whole lot of smarts to believe that kind of stupid.

Ghengis Khak October 12, 2011 at 4:52 pm

I don’t disagree with your general point here (government spending is wasteful), but I don’t follow you on part of this line of reasoning.

Paying a bureaucrat to sit idly doesn’t remove money from the economy. They will, like anyone else, spend or invest their paychecks.

The big problem is on the productivity side. In many cases they produce little, nothing, or simply make it harder for others to produce (making their net effect a negative one on productive capacity; eg the EPA).

Fred October 14, 2011 at 7:33 am

“Paying a bureaucrat to sit idly doesn’t remove money from the economy. They will, like anyone else, spend or invest their paychecks.”

Right. But when you pay someone in the private sector the person is likely getting paid to produce something of value. They are growing the pie.
Bureaucrats get paid to produce nothing of value. Thus any wealth that goes to bureaucrats is destroyed. Sure they will spend it, but they’re not trading because they’re not producing.

So it’s a net loss.

sol October 12, 2011 at 8:56 am

You know what Hayek said of Keynes after he died : “He was the one really great man I ever knew, and for whom I had unbounded admiration. The world will be a very much poorer place without him.” (wp/keynes)

But the “keynesian economics” ‘model is a construction that took place years after JMK was dead… and it’s often misinterpreted (overly simplified) by governments and commentators alike… Everyone should the general theory…

Daniel Kuehn October 12, 2011 at 9:54 am

Well, the model that the blogosphere has been arguing about and that is sort of the background for later more sophisticated models (IS-LM) was constructed in 1937 – well before he died.

sol October 12, 2011 at 8:57 am

Every should ‘read’ the general theory – sorry

Joey Donuts October 12, 2011 at 9:02 am

Did Krugman forget “ceteris paribus”? The fact that interest rates didn’t rise only tends to confirm Keynesian thought when nothing else has changed. A great deal of evidence exists that indicates that state governments decreased their borrowing because of the stimulus. I can’t point to the study I read that showed this, perhaps someone else can. That same study showed that other savings increased as well. Suppose that this increase in savings hadn’t occurred. Would interest rates have risen? Who knows? In any event the evidence for the Keynes model doesn’t exist with this model because the ceteris paribus assumption didn’t and won’t ever hold. None of the empirical models are sufficiently robust to control for all the the variables that can change. We do not have nor can we have enough evidence on all the variables. This of course raises the question, “Are Keynes’ hypothesis actually testable?”. Of course, it its not testable, then Krugman’s use of the word “believe” is a correct one.

Jim October 12, 2011 at 9:26 am

First, there is a moral argument against government spending, much less government borrowing.

Second, there is the practicality of Keynesian theory. IOW, if you are going to tax me and spend trillions and interfere with people’s choices, and otherwise trample on a free society’s rights, then you damn well better do something awesome. And that is exactly what they are not doing.

The very argument about whether any stimulus has worked is a conclusive argument against it, especially given the moral slippery slope.

Daniel Kuehn October 12, 2011 at 9:55 am

This is a real eye-opener of a post. My thoughts here: http://factsandotherstubbornthings.blogspot.com/2011/10/not-recommended-reading.html

Fred October 12, 2011 at 9:56 am

*yawn*

nailheadtom October 12, 2011 at 11:07 am

How is Keynesianism implemented without big government? The policies that are identified with Keynesian activity, rather than analysis, require a government capable of confiscating wealth and redistributing it on a grand scale.

Fred October 12, 2011 at 11:11 am

Keynesian economics is an intellectual excuse for big government.

That’s all it is. Nothing more.

Ghengis Khak October 12, 2011 at 5:06 pm

“[Russ] holds his views on Keynesianism to conform to his ideology.”

Russ’ point is that, to him, there is evidence in both directions on Keynesianism. In light of this, he sticks with his ideological bias to avoid coercive interference in the marketplace (as Krugman does on the other side).

The quoted piece makes it sound like Russ is intellectually and overwhelmingly swayed by the force of the Keynesian case, yet he eschews it all the same. I don’t think this is what Russ is saying at all.

SMV October 12, 2011 at 8:24 pm

Daniel,
I am trying to understand if stimulous spending only works as a placebo and only if peopled not realize the spending now will be taxed out later.

So at the start of a recession checks for $10,000 are sent to all adults but in the envelope was a note indicating that in 3 years their tax bill would be $10,000 higher. Or politicians spend $10,000 for each adult but with the clear understanding that taxes for each person will be $10k higher in 3 years.

Would these situations be as stimulative or only if people don’t have know their taxes will increase?

SMV

Don October 12, 2011 at 10:44 am

“We have a model of the way the world works, and the world does indeed seem to work that way.”

I could see this argument being made by the Pope 400 years ago. I’m not sure this will end any better for Keynesians today than it did for the Catholic Church during the Reformation. I just wonder if it will take them 400 years to say, “Oops, sorry, we got that wrong.”

Jared October 12, 2011 at 11:34 am

Good post, but as per my self-imposed policy, I won’t be Tweeting it or sharing it on Facebook. For the past year I have decided to go radio silent on all things related to Paul Krugman. He is beyond rescue, and I believe that most of his popularity is due to the attention that we (his opponents) give him.

I encourage others to ignore him on the basis that a) he is not worth our time, and b) the less attention he gets, the sooner the NYT might consider replacing him. Sort of like Roark and Toohey: “But I don’t think of you.”

http://www.youtube.com/watch?v=2h2ZixoCCWI

vasil October 12, 2011 at 8:24 pm

You give yourself way too much credit. The people reading Krugman couldn’t care less about what his opponents (like yourself) think about him. I navigated to Hayek’s cafe to see what wise words you folks might be offering. Finding none, I’m heading back to Krugman’s blog, where I can find some rational thinking based on real-world data.

But before I do that, I’ll share some of my own thoughts — make of them what you will.

First, the notion that “we don’t know anything, so let’s not do anything” is warped in so many ways it’s hard to count. For one, the right doesn’t come even close to following that dictum, and seems perfectly happy to enforce its views whether there’s any supporting evidence to be found or not. Exactly what factual support was there for the massive tax cuts (and resulting massive deficits) in Bush’s 1st term?

Those of us not swayed by false cries of “liberty” (hey– I don’t feel so liberated when my taxes are higher than a billionaire hedge fund manager’s) actually recognize factual evidence when it’s staring at us in the face. We recognize that financial markets operating outside a strong regulatory regime display high volatility that with some regularity requires government rescue (the tab for failed S&Ls was served to taxpayers by Reagan, as you may recall). Sorry, I’d much rather give up the “freedom” of trading anything any which way in return for enjoying the financial stability and strong economic growth we had for the half-century following the New Deal reforms. Hey, as far as the economy is concerned, even the 70s were good compared to what we have now.

Finally, for you libertarians, consider that freedom is never unlimited. Then, let’s recognize that the core freedoms of speech, assembly, unwarranted search & seizure, and so on are far more important than the secondary freedoms of property ownership and its extensions. As a country, we have long ago accepted serious limits on property ownership (taxation, eminent domain, zoning regulations, securities registration, food health standards, workplace safety, prohibition against child labor, environmental protections, and on and on). Some of these regulations go back to the early days of the nation, others were introduced over the course of the subsequent 200+ years — nearly all of them as a result of democratic pressure against obvious failures of the unregulated market. On this front, the decisions should be made by balancing both practical and moral considerations. Judgments may vary, but I don’t see any slippery slope with respect to regulating property rights.

oboe October 12, 2011 at 3:44 pm

Cafe Hack, is more like it:

http://thinkprogress.org/yglesias/2011/10/12/341947/keynesianism-and-big-government/

This blog is like the poster child for epistemic closure. As someone said up-thread: “First, there is a moral argument against government spending, much less government borrowing.”

The difference between someone like Krugman and yourself is that you guys are generally moralists looking for an economic justification; as opposed to economists.

Drew October 12, 2011 at 6:41 pm

Don: if people say “Oops, we were wrong” shouldn’t it be because there’s good evidence for saying so?

The alternative approach means never being able to say you were wrong because your arguments all start with the astonishingly boring premise that you’re right no matter what the evidence is.

Which approach is more like a pre-reformation Papacy?

Roger McKinney October 12, 2011 at 8:26 pm

“Krugman is a superb polemicist.”

I think it would be more accurate to say Krugman is a superb sophist.

BW October 12, 2011 at 9:04 pm

It’s completely insane to think that the massive expansion of government spending didn’t cause the post-WWII boom.

Very straightforward thinking tells you this: in the Great Depression, the economy was stuck in a suboptimal equilibrium with vast amounts of unused capacity; during WWII, that capacity was mobilized, increasing demand with a concomitant shift in supply; then after WWII, there was a short contraction as the economy experienced a huge shock from war to peace, but demand was still high: people had jobs and money, and businesses could invest in new capacity anticipating a new surge of private spending.

Russ claims this very intuitive explanation of events is discredited because of what Keynesians said at the time. Are you kidding? The theory wasn’t even 10 years old yet. Obviously they hadn’t worked out all the kinks. That’s like saying Newton’s laws were garbage when he first developed them because he didn’t have a theory of air resistance.

Why don’t you address what modern, developed Keynesian analysis has to say about the Great Depression? Oh, right, because you can’t.

Here’s an analogy. Lots of supply-siders predicted in the 1980s and 1990s that the U.S. is on the right side of the Laffer curve, and that tax rate cuts lead to increases in tax revenues. OK, now we all know that’s false. But it doesn’t discredit the idea of the Laffer curve, does it? It was just an empirical prediction gone awry. As long as that false prediction isn’t consistently recycled and asserted as truth, it’s no big deal. That’s how knowledge progresses. Nowadays most people think there is a Laffer curve, but that its turning point is at high marginal rates.

BW October 12, 2011 at 9:31 pm

All of you “taxation is theft” types were absolutely schooled by Bruce Bartlett in the Times recently. He showed the very strong correlation between societies with low levels of taxation, and total societal dysfunction: e.g. Congo and Libya. As it turns out, taxation is a good thing in modest doses. It permits the state to implement a form of social contract that prevents life from descending into the Hobbesian brutishness that happens (sadly) to be the state of affairs in libertarian societies like Somalia and Eastern Congo.

As for the idea that consuming is only of value when done voluntarily, and that fiscal stimulus is like forced consumption . . . again, that just shows a complete lack of understanding of the underlying concepts. First, nobody is ever forced to consume anything. Government spending puts people to work, and that is all. They make their own consumption decisions. As it happens, many people are highly consumption constrained by lack of resources, which is why spending has a high multiplier and tax breaks on wealthy people does not.

More importantly, people’s consumption decisions are affected by their predictions of future income. They *would like* to be spending more, but if they are jobless or worried that they might be jobless, they will not. If the government decreased the uncertainty about their future income stream, then they voluntarily spend more. It just so happens that the government can do this simply by *encouraging* spending, which lifts demand, which then boosts supply, and the economy is back to full capacity. The idea that there is something improper or immoral about this process is insane.

Methinks1776 October 12, 2011 at 9:50 pm

I’m convinced. Before the 16th Amendment, the United States was just like the Congo and Somalia. Life had descended into the Hobbesian brutishness that required a subset of brutes to rob all other brutes to in order to de-brutify society. It is thanks to taxation that this subset of angelic brutes is able to work its magic on the rest of us with a social contract whereby the subset of brutes becomes wealthy at the expense of the peasant brutes and, in this way, makes peasant brutes less brutish, more subservient and meek. Good point.

Don Boudreaux October 12, 2011 at 10:02 pm

“de-brutify society” – I love that term! And being a brute, I will steal it from you. ;-)

Methinks1776 October 12, 2011 at 10:34 pm

Is okay. I will make another.

TheColourfield October 12, 2011 at 10:21 pm

For the tax is theft crowd as eloquently stated by John Scalzi

“I really don’t know what you do about the “taxes are theft” crowd, except possibly enter a gambling pool regarding just how long after their no-tax utopia comes true that their generally white, generally entitled, generally soft and pudgy asses are turned into thin strips of Objectivist Jerky by the sort of pitiless sociopath who is actually prepped and ready to live in the world that logically follows these people’s fondest desires. Sorry, guys. I know you all thought you were going to be one of those paying a nickel for your cigarettes in Galt Gulch. That’ll be a fine last thought for you as the starving remnants of the society of takers closes in with their flensing tools.”

Methinks1776 October 12, 2011 at 10:39 pm

That is very eloquent. I am once again convinced that the only thing standing between my soft, pudgy ass and jerky is the collection of pitiless sociopaths on Capitol Hill.

TheColourfield October 12, 2011 at 10:47 pm

Their proper name is the Republican Party.

Methinks1776 October 12, 2011 at 11:40 pm

The Republican Party is keeping my corpulent ass from its fate of becoming a salty, tough snack. Got it. I will remember that November of next years. You have opened my eyes – and with such imagery too.

BW October 12, 2011 at 9:40 pm

Some of you lack any reasonable understanding of interest rates.

Um, the Fed controls interest rates in the short term . . . if its resources are up to the task. It cannot control interest rates in the long term, nor stave off an attack on the debt.

A simple thought experiment confirms this. If Fed intervention can by itself keep rates low, then why do countries ever experience high interest rates? Why didn’t the Bank of England simply intervene against George Soros to prevent the attack on the pound? Or the Banks of Korea, Thailand and Indonesia against the financial crisis of 1997? Oh, wait . . . they did. It didn’t work . That’s because central banks generally cannot prop up an equilibrium when there are powerful market forces allayed against them.

If the market wanted interest rates on the U.S. debt to increase, it would achieve that goal quite easily. Treasuries would be sold, and sold, and sold . . . until the Fed had no ability to buy anymore without massively printing money, at which point inflation would run rampant (since we’re assuming the market doesn’t want U.S. treasuries, it follows that it wouldn’t want dollars either). That’s *precisely* the prediction of the anti-Keynesians. And it’s been completely wrong.

Methinks1776 October 12, 2011 at 9:45 pm

Um, the Fed controls interest rates in the short term

The Fed attempts to manipulate interest rates at the short end of the curve and it does so pretty successfully. It has virtually no control over rates at the medium and long end of the curve – which is why QE2 was such a failure.

A Coates October 13, 2011 at 1:05 am

/clap. Thank you for introducing something reasonable into this thread. My head was starting to hurt.

Greg G October 13, 2011 at 7:26 am

Methinks, I am not a fan of QE2 but it seems obvious to me that the Fed has held down interest rates at the long end of the curve whether or not you think that is a good idea. How much lower could they be? I understand why this may be a terrible idea and cannot work indefinitely without causing far more inflation than we would be willing to tolerate. Is that your point or are you arguing that the Fed’s actions have not been holding down the long end of the curve?

Methinks1776 October 13, 2011 at 7:57 am

Greg G, the curve was steep before QE2 and it was steep during and after QE2. QE2 was meant to flatten the curve. Where’s the “obvious”?

Methinks1776 October 13, 2011 at 7:58 am

Of course, QE2 did raise inflation. Maybe this is what you mean by its “obvious” success?

Greg G October 13, 2011 at 9:46 am

Methinks, OK I get your point about the yield curve in QE2. I really meant to ask about the current QE (whatever number it is up to now) You do agree that the curve is pretty flat for now and that QE right now is having that effect at least for a while right? How much do you think it raised inflation? I expect it raised it less than they were hoping.

Methinks1776 October 13, 2011 at 10:04 am

No, Greg I don’t agree. first of all, the curve is not flat. It is quite steep. Second, there’s no QE going on right now. The Fed ended QE2 this summer. Two reasons for ending QE2 is its utter failure in flattening the curve and its effect on inflation.

Any flattening of the curve happens when capital flees dodgy places like Europe or post-earthquake Japan into U.S. Treasuries.

Pablo October 12, 2011 at 10:22 pm

Keynes didn’t want big government per se, neither do Keynesians.

Dan H October 12, 2011 at 10:48 pm

Dr. Krugman,

It’s very disingenuous of you to post here under an Hispanic translation of your name.

Nicholas Gruen October 13, 2011 at 12:36 am

“Does Krugman really believe that you can’t have high interest rates when there is high unemployment.”

Um – no he doesn’t. He didn’t say so. He said – indeed you quoted him as saying “Anti-Keynesians assured us that budget deficits would send interest rates soaring; Keynesian analysis said they’d stay low as long as the economy remained far from full employment. Guess who was right?”

Russ, can you see why the juxtaposition of those two quotes has me thinking you are not trying to meet Krugman on his strongest points (which is the only way this debate could be productive)?

Sam Brasel October 13, 2011 at 8:47 am

“I’m an anti-Keynesian because I want smaller government.”

I for one appreciate the fact that you concede that you are reasoning and writing in bad faith; that is, that you are reaching your conclusion prior to any good-faith attempt to objectively analyze the facts.

Apparently if you believed that the theory of gravity was contrary to achieving smaller government, you would be anti-gravity as well. OK, understood.

oboe October 13, 2011 at 9:50 am

Precisely. Hence, “Cafe Hack.”

George Bush October 13, 2011 at 8:49 am

So you are anti-Keynesian because you believe smaller government is best??? What happened to relying on the evidence?

I believe in the Bible, therefore creationism must be correct.

Duh.

Charlemagne October 13, 2011 at 9:58 am

I read your post and then Krugman’s defense and I can clealry see you’re pretty out of his range. No wonder you admitted he’s a superb polemicist… but there’s more: he’s intelligence is not based in ideology.

Methinks1776 October 13, 2011 at 10:09 am

Not that he admits. Or do you think when the lights go out you go blind?

Economiser October 13, 2011 at 10:34 am

Krugman’s Keynesianism relies on extreme faith in macroeconomic models. However macroeconomic models are very inaccurate (cf. Hayek’s pretense of knowledge). They also have the unfortunate characteristic of false precision; that is, a model will spit out a precise number to however many decimal places you want, but the entire thing suffers a “garbage in, garbage out” flaw. You can tweak a model’s assumptions to get pretty much whatever result you want.

In order to believe Keynesian theories about the economy, you need to believe that the well-established economic relationships that hold at the micro level somehow break down (and even work backwards) at the macro level. I’ve never seen a good explanation for why this would be the case. This is why I put no stock whatsoever in Keynesian theory. They forget that the economy is a collection of human actors each responding to ever-changing elements, not simply variables that you can plug into an equation.

Buzzcook October 13, 2011 at 11:18 am

There was a recession after WWII, as there is after every war. The recession was short and ended for many reasons. In part because the US government paid for the college education of thousands of workers through the GI Bill. It also gave away or sold at fire sale prices, the factories it had built/paid for during the war. Government also lent thousands of people money to buy new homes.
While there was a contraction in government after WWII, there was an increase in non-military spending.

Andrew_M_Garland October 13, 2011 at 12:47 pm

Links?

John R. Graham October 14, 2011 at 10:14 am

Krugman cites (and links) to a 2009 paper by Almunia et al that claims monetary + fiscal stimulus of 1930s was effective in Italy, Germany, +Japan. So, the solution to our problems, apparently, is to invade North Africa, Eastern Europe, and China.

Ottovbvs October 14, 2011 at 10:29 am

Actually I’d say Krugman did more than defend himself he rather demolished Russ. Not suprising really because he really is a very clever guy, but also because this comment by Mr Graham just about encapsulates where the mindset of the Russ clones is located.

Rick October 14, 2011 at 10:50 am

Professor Roberts, can you respond to Professor Krugman’s response regarding the nature of conservatism and liberalism? I don’t know a single liberal who “wants bigger government”. The size of government is simply a by-product, the result of pursuing a system that maximizes certain economic and social outcomes. The idea that liberals like government for its own sake and want more of it is constantly put forth by those who see small government as something valuable in and of itself.

As somebody who tends to lean slightly liberal, but who is a regular podcast listener and is often swayed by more free-market oriented arguments, I would LOVE to have you guys cut out the middle men and simple have a logical, ONGOING conversation in the public light. The biggest problem with free markets, as far as I can tell, is massive information asymmetries. And the field of economics is clearly not immune.

If economists are truly in pursuit of truth and understanding, why do they refuse to earnestly engage in activities that threaten their views? Perhaps it’s because they value the feeling of being right and abhor situations which place that feeling at risk. Stop talking past each other. How about you guys pick an issue, get all of your evidence together, and try to sort it out in the public light. Heck, I’d just like to see an agreement on some basic facts. This would be truly educational.

Though I suppose it would entail the possibility that one of you would be on the “losing” end of things. And since that would threaten your livelihood, you’ll both just continue to sit in your ivory towers shouting in each other’s general direction. I’ll continue to listen to your interesting conversations, but would love to see you actually engage in somebody you disagree with for the purpose of resolving the disagreement rather than for mere entertainment.

Matthew Gray October 15, 2011 at 9:44 pm

“He leaves out the post-WW II expansion that followed huge cuts in government spending where the Keynesian predictions were totally wrong.”

Followers of Keynesian economics don’t see it that way. They have no problem at all fitting the post-WW II expansion within their theoretical framework. The post you linked to explains why:

“The usual way that Keynesians explain the post-war expansion despite the huge cut in government spending is to say, well of course the economy boomed, there was a lot of pent-up demand.”

When the government started rolling back spending in 1945 the economy went into recession for about 6 months and shrank 10%. By the time 1946 rolled around the economy was growing again largely because all the pent-up demand from the war years allowed the public sector to pick up the slack. The end of the war saw a significant increase in exports to Europe and Japan and that contributed to the expansion as well.

You have a question about this explanation:

“What does that (pent-up demand) mean? There is always pent-up demand in the sense there is a stuff I wish I could have but can’t. But the standard story is that people couldn’t buy washing machines or cars during the war–they were rationed or simply unavailable or unaffordable. So when the war ended, and rationing and price controls ended, people were eager to buy these things.”

People’s eagerness to buy things after the war is part of what’s meant by pent-up demand, but there was a much more important factor. By restricting people’s ability to purchase goods, rationing and price controls had the indirect effect of increasing the savings rate. They couldn’t spend money even if that wanted to. As a result, when the war ended the public had a massive amount of money to spend and invest during the transition towards a peacetime economy. That’s what people mean when they talk about pent-up demand. The amount of money the private sector was pumping into the economy was greater than the amount the government was pulling back. This helped create the postwar economic expansion.

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