Tuesday, July 19, 2011

Keynsian economic theory would bring America out of the current economic slump - the GOP will not permit that.

Ezra Klein has provided an excellent summary of the Keynesian solution to the current economic crisis and why it works. He bases his description on the analysis by Lawrence Summers, one of the best known current Keynesian economists.

What has happened is that Keynes is rather complex and the GOP prefers simple explanations. It's part of their current wave of anti-intellectualism. Ezra mixes the political reaction by the politicians with the economic theory, but I'd rather provide the theory first.
“I think Keynes mistitled his book,” Summers says. “The correct title would have been ‘A Specific Theory of Collapsing Employment, Interest and Money.’ What his book really was about was the proper understanding of the convulsive downturns to which a free-market economy is intermittently prone.”

The idea, in other words, is not about whether the government spends money better than individuals. After all, a lot of the policies advocated by the Keynesians, like the Making Work Pay tax cut, put money into the hands of individuals so that they can spend it. The idea is that the government has a role to play when, because of a “convulsive downturn,” a crisis begins feeding on itself.

Keynes — and others who later elaborated on his work, like Hyman Minsky — taught us that although markets are usually self-correcting, they occasionally enter destructive feedback loops in which a shock to, say, the financial system scares business and consumers so badly that they hoard money, which worsens the damage to the system, which further persuades other economic players to hoard, and so on and so forth.

In that situation, the role of the government is to break the cycle. Because businesses and consumers have stopped spending, the government breaks the cycle by spending. As clean as that theory is, it turned out to be a hard sell.

The first problem was conceptual. What Keynes told us to do simply feels wrong to people. “The central irony of financial crises is that they’re caused by too much borrowing, too much confidence and too much spending, and they’re solved by more confidence, more borrowing and more spending,” Summers says.

The second problem was practical. “What I didn’t appreciate was the extent to which we only got one shot on stimulus,” Romer says. “In my mind, we got $800 billion, and surely, if the recession turned out to be worse than we were predicting, we could go back and ask for more. What I failed to anticipate was that in the scenario that we found we needed more, people would be saying that what was happening showed that stimulus, in general, didn’t work.”

And even if Congress was willing to green-light more money, spending it turned out to be harder than the Keynesians had hoped. “Anybody who is honest and knowledgeable will say it is harder to move money quickly and well in reality than it is in the textbook model. I don’t think the idea that lots more money could have been moved is credible unless there had been a whole set of prior planning,” Summers says.

Prior planning, it turns out, is important. Keynesianism might be a theory of crises, but it requires planning during non-crisis periods. And looking back, we weren’t prepared to go Keynesian. At all.

For one thing, if you’re going to spend during downturns, you have to save during expansions. That wasn’t a big part of George W. Bush administration policy, of course.

Another clear takeaway is that formulas are more reliable than Congress. It would be much better if federal support for programs such as Medicaid and unemployment insurance was explicitly tied to the unemployment rate. Hoping Congress will act responsibly over any extended period of time isn’t, as they say, a plan.

It would also be good to keep projects in “shovel-ready” condition when times are good so that federal money could be used effectively and quickly when times turn bad. Undeniably, the country’s infrastructure needs are great. If the federal government made a more explicit commitment to invest in infrastructure during downturns, states could be given the certainty and the incentives to keep a long list of projects ready to go.

But rather than improving on Keynes, the Republican Party has turned against him and the Democratic Party has stopped trying to defend him, much less continue to implement his recommendations.

“The polarization of fiscal policy is one of the worst legacies to come out of the recession,” Romer says, sighing. “Before the crisis, there was agreement that what you do when you run out of monetary tools is fiscal stimulus. Suddenly, it’s like we’re back in the 1930s.”

[Highlighting is by editor of WTF-o]
So Keynesian theory provides a solid basis for how to deal with the economic convulsion caused by the long housing bubble and the politically-oriented low interest rates that Greenspan engineered to reelect Bush. But the practical difficulties of applying the theory mask its effectiveness. It works, but it's not easy.

That has allowed the opposition party (the GOP) to demagogue the stimulus so that, as Larry Summers said, he thought that if the stimulus was not big enough to deal with the downturn the administration could go back for more. Instead of supplementing the previous stimulus as is needed, the GOP has reverted to the economic ignorance popular among bankers and businessmen during the 1920's and 1930's before Keynes published his book.

The impetus for the GOP is first their effort to regain the White House at any cost, even if they have to take down the American economy and the world economy to do so. The second reason is, as I wrote above, the GOP base is highly anti-intellectual and rejects policies recommended by academics based on theory. It does not matter how well-proven the theory might be. If it's not intuitively clear to the man in the street, the GOP tends to reject it. (This is the conservative reaction to social science theory. They will accept physical science theory because it does not clash with their strongly held social and religious beliefs as provided by right-wing preachers and politicians.)

The result of those conservative attitudes is summed up by Eric Cantor.
“The president’s team were fervent believers in the theories of a British economist called John Maynard Keynes,” wrote Majority Leader Eric Cantor (R-Va.) in his election-year manifesto, “Young Guns.”
This clash of conservative ignorance and intransigence against the economic disaster they have caused is what is giving us the fake debt crisis and which is likely to cause further economic distress for America for a long time.

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