Is Mitt Romney a closet Keynesian?
John Maynard Keynes said back in 1936 that “practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” Keynes himself is now a seemingly defunct economist, but his influence connects the two most important events of the week and perhaps of the year: the sudden reversal of fortunes in the U.S. election and the powerful critique of overzealous fiscal austerity produced by the International Monetary Fund.
What connects these two events is an economic question that almost nobody dares to raise publicly, but that now seems destined to dominate the U.S. election and that hung over the IMF annual meeting in Tokyo this week: Do deficits really matter? Or, to restate the issue more precisely: Are government efforts to cut budget deficits counterproductive in conditions of zero interest rates when fiscal austerity suppresses economic growth?
This conclusion is strongly suggested by the IMF’s “World Economic Outlook” produced for the annual meeting. The WEO presented six detailed case studies, starting with Britain from 1918 to 1939, of economies that tried to reduce large public debt burdens with various policy mixes in the past 80 years. It concluded that two conditions were essential for success: very low interest rates and adequate rates of economic growth. If fiscal austerity produces high unemployment and economic stagnation, it is doomed to failure, causing the government’s debt burden to go up instead of down. After examining this historical evidence, the IMF report hinted strongly that at least two major economies were now caught in self-defeating debt spirals: Spain, where the debt trap is created by political pressures from the euro zone, and Britain, where the futile austerity is entirely self-imposed.
The British example is particularly striking. While the British government has implemented bigger tax increases and spending cuts than any other major economy apart from Spain (equivalent to 4.3 percent of GDP since 2009), it has suffered a double-dip recession, missed all its fiscal targets and seen its national debt nearly double from 46 percent to 84 percent of GDP since 2009. Meanwhile, the U.S., which started with a bigger deficit and debt than Britain in 2009 and has made very little effort to tighten fiscal policy since then, has seen its net national debt grow considerably more slowly, from 54 percent to 84 percent of GDP. The better U.S. fiscal performance, despite far less fiscal “effort,” has been due entirely to faster economic growth.
Which brings me to the presidential debate last week. Mitt Romney won the debate largely by denying that his plan for a 20 percent tax cut would increase the U.S. budget deficit. Pressed to explain where the money for his tax cut would come from, Romney spoke of eliminating “deductions and exemptions [so] we keep taking in the same money when you also account for growth.”
But in interviews since the debate, Romney has promised not to touch any of the loopholes big enough to compensate for a 20 percent reduction in tax rates – mortgage interest, charitable contributions and healthcare. That has led most analysts to conclude either that Romney is not serious about cutting taxes or (more probably) that he is not serious about fiscal arithmetic and will allow deficits to explode.
There is, however, a third possibility. Perhaps large tax cuts would boost the U.S. economy so strongly that the lost revenues would quickly be restored through rapid income growth? In the Denver debate, Romney focused on this growth theme: “The revenue I get is by more people working, getting higher pay, paying more taxes. That’s how we get growth and how we balance the budget.”
Many Democrats instinctively reject the possibility of self-financing tax cuts, accusing Romney of “magical thinking” and likening his approach to Reagan’s trickle-down economics. But let us not forget that Reaganomics proved remarkably successful, generating average growth of 4.7 percent annually for six years. And neither should Democrats forget that self-financing fiscal stimulus, whether through tax cuts or public spending, is the essence of Keynesian economics.
Was Reaganomics successful because of Keynesian demand stimulus or conservative supply-side economics? Nobody can say for certain, and most likely there were benefits from both incentive and demand effects. But either way, Reagan was hailed as a national savior. Romney would be equally lauded if his tax cuts delivered strong economic growth, regardless of whether budget deficits initially expand, as they certainly did under Reagan.
This statement may sound like “deficit denial” – and in a sense it is – but the IMF has now produced persuasive evidence to back it up. This week’s WEO reports a new study of fiscal changes in 28 countries since the Lehman crisis, which shows fiscal policy working in much the way that Keynes predicted, but with two to three times more impact on GDP than previously supposed. The very high fiscal multipliers identified by the IMF suggest that big tax cuts could indeed be largely self-financing, as Romney hopes.
That fiscal policy is now much more powerful than in the past is hardly surprising. The world is again stuck in a liquidity trap, in which monetary policy is ineffective, much as it was in the 1930s, when Keynes developed his ideas on fiscal stimulus. How ironic that it now takes a conservative such as Romney to stop panicking about deficits and propose a full-scale Keynesian policy for growth.
PHOTO: Stacks of U.S. hundred-dollar bills are displayed during a presentation to the media in Mexico City, November 22, 2011. REUTERS/Bernardo Montoya