Looking for Keynes’ angels

September 14, 2010

Keynesian stimulus works perfectly, but only if you can find politicians who don’t care about re-election and central bankers who aren’t interested in being liked.

The Obama administration, confronted with staggeringly high unemployment and a struggling economy, has proposed another round of, well, stimulus, this time in the form of tax cuts and investment incentives, but such is the toxicity of the word in current debate they can barely bring themselves to utter the “S” word.

As envisioned by economist John Maynard Keynes, in order to successfully run an economy based on counter-cyclical spending during downturns, you need to also have a policy of counter-cyclical savings during fat times. Budget surpluses must be built up so that they can be run down during recessions

It is brilliant advice, but really should begin with “first elect angels,” because the natural tendency is usually for the election cycle to dominate the thinking of those whose survival depends on it, with concerns about the economic cycle downgraded to a secondary issue mostly important because it might one day influence elections and careers.

This isn’t so much a criticism of current U.S. policy. The stimulus should never have been launched from a fiscal position as weak as it was.

The ratio of government debt to gross domestic product grew almost continuously throughout the last decade. After reaching a low of 56.4 percent in 2001 it climbed steadily and was at 64.4 percent in 2007. Compare that to the figures in the 30 percent range that prevailed during most of the 1970s, or if you dare, to the 100.8 percent that the Congressional Budget Office is forecasting for 2012, the highest such figures since the U.S. was working down debt taken on in World War II.

Whatever you think about the current stimulus, it is fair to say that the return on investment will be a good bit lower than saving the world.

It is easy, of course, to build systems which will only work if operated by heroes: Karl Marx did something similar with communism, which would have worked a treat if only the workers were indifferent to rewards and uninterested in self-determination and autonomy.

Keynes’ error is of course several orders of magnitude less, but the sense of a well meaning plan bumping up against the crooked timber of humanity is the same.


There is little doubt that the last round of stimulus blunted the impact of the recession, so the question becomes: why is it so unpopular?

In part this is because the stimulus is confused with the bailouts of the banking and auto industries, policies that may or may not have been necessary but most definitely were hackle raising. This made it easy to tar the original stimulus package with the lie that it was more reward for failure and self-dealing.

In addition though, there is at the core of the opposition to the stimulus an understanding that the system is biased towards profligacy and that those in charge cannot be counted on to take hard decisions if those decisions are politically unpopular.

It is important to note that the real runaway growth of debt has happened since the end of the Bretton Woods system, under which foreign currencies were convertible to the U.S. dollar at fixed rates, the U.S. dollar itself being convertible to gold.

That system was abandoned under Richard Nixon because, at base, the effects of paying for the Vietnam War were too politically unpleasant.

Government debt to GDP in the U.S. has been marching upwards since, with a brief respite as the budget was briefly balanced under President Clinton.

It is significant that the last round of increasing debt during the last decade was driven by a desire to cut taxes, stimulate the economy and run extremely expensive wars all at the same time.

Getting rid of Bretton Woods has given latitude to stimulate more, but also to run up more debts while delaying the consequences.

It may well be that people who are against more stimulus for the U.S., which still possesses the world’s primary reserve currency, are wrong, and that the economic outcome without further stimulus will be worse.

What cannot be denied is that Keynesian-ism in a post Bretton Woods world has tended towards excesses punctuated by crises, and that the crises have been successively worse.

Clearly markets show few sign of punishing the U.S. for over-borrowing, but just as clearly the costs of a market loss of confidence in a sovereign borrower are so high, and come on so quickly, that insurance by way of fiscal restraint may prove cheap.

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