Sunday, August 16, 2009

So much for Keynes

Over the past year or so, much of the press and the political class have been talking about how Keynesian policies are making a comeback. Things like government spending to stimulate the economy, etc are all in vogue now.

Although I think Keynes general theory does not work, I understand the intuitiveness of his theory. I think that the key premise of the his theory is that government needs to be counter-cyclical to the economy. In other words, governments should be hiking taxes/cutting spending/removing stimulus in up cycles and increasing spending/cutting taxes/adding stimulus during downcycles. The premise being, that government would temper the excesses of up cycles by pulling excess capital out of the market by fiscal policies and the severity of down cycles would be minimized as well.

Once again, the destroyer of most economic and political theories is once again - human nature. Recent history has shown how politicians cannot help themselves. During the up cycles through 1991-2007, federal and state governments slashed taxes and ramped up government programs - goosing an economy fueled by artificially low rates. Now, that times are tough - these same governments are cutting spending and raising taxes (at least on a state level, the federal government is raising taxes and increasing spending), which will not help one bit.

The problem is that politicians are incapable of not expanding the scope of government: they are addicted to increasing spending and incapable of cutting it. The taxes are just the result of this problem. This is why Keynes belief that government spending must be counter-cyclical cannot be a reality.


Realist Theorist said...

Keynes was wrong on the practicality of ever pulling back government spending. However, the notion that counter-cyclical action is helpful is also wrong on its own terms. To the extent that a recession is shallow, it will also be wide. It sacrifices the most marginal workers (and others who have to suffer the prolonged downturn) to the next "layer" of slightly less marginal workers who do not get laid off.

R.D. Bresnahan said...

When you find an economic theory that actually works ...or for that matter... an economist that actually deals in corporeal reality let us know