Keynesians just don’t get it

Unless you are explicitly anti-Keynesian you are for all practical purposes pro-Keynesian. There is one economic issue at the moment that is paramount and that is whether public spending can add to economic growth and employment or whether such expenditure actually damages a country’s growth and employment prospects. And building from that is the question whether a major part of the answer to contemporary economic problems are cuts to public spending.

However you look at it, this is the core issue of Keynesian economic theory and the policy that comes with it. If it is your conclusion that increases in non-value-adding public spending can contribute to growth and employment you are a Keynesian. If that is not your conclusion, that you think it will make things worse, then you are not. There is nothing else to it. At a minimum 95% of all economists practising today accept the Keynesian premise. At a maximum there may be 5% of the profession who do not. Even with the dismal and disastrous effects of the stimulus everywhere to be seen, either the stimulus was insufficient or it saved us from far worse are the standard answers. That we are now living out the consequences of a major and fundamental error in policy is virtually stated nowhere. The debate over Keynesian economic theory has not even begun never mind having been brought to an end.

The supposed locus of anti-Keynesian sentiment was found in a paper by Carmen Reinhart and Kenneth Rogoff discussed here. R&R argued in a jointly published book that “when a government’s debt rises to 90 percent of its country’s gross domestic product, the country’s economy contracts by (on average) one-tenth of one percent per year.” Turns out that their maths may have been wrong and the descent not as precipitous as that.

The usual motley crew of Keynesians therefore piled on to discredit the very idea of fiscal sense. The most recent and central of this Keynesian assault has been a book review by Paul Krugman in The New York Review of Books under the catchy title, “How the Case for Austerity has Crumbled” which would have been far better titled, “Who You Gonna Believe, Me Or Your Lying Eyes?”.

As scholars, R&R have had their feelings bruised and are now attempting to reply to their critics. Rogoff has written an article which was forwarded to me from Canada’s Globe and Mail which came with the title, Anti-austerity: Keynes never met the euro zone. It’s not, you see, Keynesian economics that is intrinsically wrong, it’s only just that the particular circumstances of the Euro as a single currency unit that are at fault. Here is the final para of the article which tries to deflect attention away from Keynesian theory per se:

To my mind, using Germany’s balance sheet to help its neighbours directly is far more likely to work than is the presumed ‘trickle-down’ effect of a German-led fiscal expansion. This, unfortunately, is what has been lost in the debate about Europe of late: However loud and aggressive the anti-austerity movement becomes, there still will be no simple Keynesian cure for the single currency’s debt and growth woes.

“No simple Keynesian cure” of course leaves room for a more complex Keynesian cure which would be appropriate in a different set of circumstances. Since it’s all numbers without theory who knows what anyone believes about anything, and that even includes Rogoff himself who may be completely baffled by his own results.

But prior to that R&R wrote a joint post on Reinhart’s blog titled Letter to PK. Their problem is with debt, not with Keynesian theory. To wit from the paper:

Let us be clear, we have addressed the role of somewhat higher inflation and financial repression in debt reduction in our research and in numerous pieces of commentary. As our appendix shows, we did not advocate austerity in the immediate wake of the crisis when recovery was frail. But the subprime crisis began in the summer of 2007, now six years ago. Waiting 10 to 15 more years to deal with a festering problem is an invitation for decay, if not necessarily an outright debt crisis. The end may not come with a bang but with a whimper.

And from that Appendix, first Reinhart:

Reinhart Testimony before Senate Budget Committee, February 9, 2010. ‘In light of the likelihood of continued weak consumption in the U.S. and Europe, rapid withdrawal of stimulus could easily tilt the economy back into recession. To be sure, this is not the time to exit. It is, however, the time to lay out a credible plan for a future exit.’

And then Rogoff:

Farheed Zakaria, GPS ‘Krugman calls for Space Aliens to Fix US Economy,’ August 12, 2011, Ken Rogoff: ‘Infrastructure spending, if it were well-spent, that’s great. I’m all for that. I’d borrow for that, assuming we’re not paying Boston Big Dig kind of prices for the infrastructure.’

But how bout cutting all that wasteful public spending that is going on right now? Rogoff again:

The Economy and the Candidates, Wall Street Journal Report with Maria Bartiromo, October 21, 2012 (interview with Kenneth Rogoff) on Fiscal Cliff: ‘Hopefully we won’t commit economic suicide by actually putting in all that tightening so quickly. I like to see something like Simpson Bowles….If we did, we could have our cake and eat it too, we could have more revenue without hurting growth.’

And here the two of them signing off on a joint statement:

A couple of Senator Coburn’s quotes from us at the meeting, taken without the full context of our introductory remarks have been interpreted as saying we endorsed immediately closing the budget. This was at odds with our position, notably our work on slow and often halting recoveries from financial crises, which we also emphasized. In fact, taking into account our opening remarks, it is our impression that the Senators full well understood the urgency we were expressing referred to adopting a long-term Grand Bargain a la Simpson Bowles.

No one supports immediately closing the budget since it cannot be done “immediately” anyway. But as Simpson-Bowles will take more than a decade, you cannot interpret R&R’s underlying theoretical position as stating that wasteful spending is the problem that must be cured.

As I read what they wrote my conclusion is that they don’t get it. They just don’t get it. They don’t see that the wasteful spending is the problem in and of itself. That they share this perspective with 95% of economists means that there is no constituency whatsoever in favour of taking the only kinds of actions that will actually produce a return to a solid foundation for future economic growth, higher living standards and full employment.

Steve Kates teaches economics at RMIT University. His most recent book is Free Market Economics: an Introduction for the General Reader