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A Blast From the Past

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From a transcript of Planet Money, January 29, 2009 [2], right before the stimulus was passed:

Economists and policymakers started looking around for some other way to fix things. They dusted off some old books and found that there’s one guy in particular who’d given a lot of thought to get out of a situation like this.

“So, here’s the way Keynes would have done it,” Blinder says, sketching points on a blackboard in his office.

The Keynesian formula is straightforward. First, you estimate how much the economy should be producing — given all the people and factories and offices. Blinder’s guess is $15 trillion. Then you look at what the economy is actually producing. He puts that at $14 trillion.

The government shouldn’t have to spend the entire trillion-dollar shortfall. That’s because of something called the “Keynesian multiplier.” Every dollar the government spends produces more than a dollar in spending throughout the economy. If the government pays you to build a bridge, you spend your paycheck on rent and food and so on, and then your landlord and grocer have money. Using Keynesian math, you can figure out exactly how much the Obama administration should spend.

Blinder taps his chalk, winding up his calculations. “That would lead you to conclude that you needed about $650 billion as a stimulus,” Blinder says. “Voila! That’s the kind of number they’re talking about right now. You see it in the newspapers every day, a number in that range.”

Here’s how the piece ends:

Many of the economists say they just don’t know whether the Keynesian approach will work. Financial catastrophes don’t happen often enough to prove theories like his. In fact, as economists like Blinder will tell you, this is the problem with economics.

“The biggest problem with learning things in economics is the inability to do controlled experiments,” Blinder says. “So we don’t have, unlike what is the case in many sciences, the definitive experiment. This experiment they did in the 1920s proved that Einstein was right about the perturbation of Mercury. It proved. We can never do that in economics. The best you can have is a really good theory. It’s not going to work perfectly in a textbook manner all the time.”

Anti-Keynesians say this massive stimulus package is too risky an experiment on an unproven theory. It might not get America out of the recession, they say. It might cause vicious inflation and a bloated government, and leave a trillion more dollars in debt as a constraining burden on Americans’ children and grandchildren.

The Obama administration is betting that won’t happen. They’re trusting this theory. They’re trusting Keynes.