Keynes and Stimulus

This is not the time and place to start a discussion on what has passed for economic theory over the past century. Suffice to say, if we had a working theory accepted by all policy makers, we would hardly be in the present pickle.

It is a fairly obvious step in thinking to realize that a sharp drop in demand is likely best offset by a rise in government sponsored demand. So far, so good. It is here that clarity evaporates.

The economists and the present political consensus have always failed to understand that demand expansion must be properly directed to maximize economic impact.

The second war is misleading because about the only place a dollar bill could be used was in the USA. Vietnam saw huge amounts of that government spending land in the creation of the Eurodollar market with limited direct benefit to the USA. The present war is doing much the same with far less benefit than possible unless you think swiss bankers are your friend.

The real stimulus program that has worked is the space race and the advent of techno war and the massive research and development budget associated with that. That money lands in the USA, in the most stimulating manner possible. And yes, stimulating the housing market with a credit bubble was downright stupid.

You wonder why I think most economists to be dumber than a bucket of bolts?

For the present, we have stabilized the major banking system by the simple expedient of replacing the losses on their balance sheets. Because the money is already lost it is already in the economy and this is not inflationary at all. This should prevent us from having a rerun of the great depression. But it is not stimulus.

The good news today is that the collapse frenzy appears to have run its course. Bernacke is even upbeat, which suggests hard demand has kicked in and the numbers care now on an uptick. We still have a zombie credit system that will take a long time to clean up unless they choose to be aggressive as I have suggested. However, since they are still dumber than a bucket of bolts, we are likely in for a decade of slow growth and massive drops in government revenues everywhere.

The housing market is stabilized only because the banking system cannot sell inventory today without crystallizing a larger loss than they are currently carrying. It is now a case of selling a foreclosed house and losing a billion dollars as inventory prices drop.

This from club Hyack.

What Keynes really meant (by Russell Roberts)

Posted: 15 Mar 2009 02:21 PM PDT

Over at this bloggingheads conversation with Arnold Klings, some commenters thought we weren't fair to Keynes. Here is the response I posted there:

What did Keynes really mean? It's hard to say. His masterwork is a bit opaque and has been interpreted by many generations of acolytes.

In the current environment, we are told that consumers aren't spending so aggregate demand has fallen. (This is typically discussed as if the reason for this drop is irrelevant). Therefore government must step in as the spender of last resort. This was the defense of the so-called stimulus package of $787 billion. Those who defended it did not defend it on the merits of what was in it, but rather simply on its magnitude. And many of those defenders (including Paul Krugman and Robert Reich) said it was not big enough.

Their basic argument is Keynesian in nature—that aggregate demand, C+I+G, must be boosted up to its former level and that this can be achieved through an increase in G. And according to the Administration (and the study it produced written by Jared Bernstein and Christina Romer), every dollar of government spending would produce 1.57 (or was it 1.54?) dollars of income.

The presumption is that it does not matter what G is spent on. The most important thing is to get spending into people's hands so that they will in turn spend it and the multiplier will kick in.

The presumption is that the multiplier is a constant. It does not matter how G is financed. It does not matter what G is spent on. It does not matter why C is down. G just needs to go up. This is silly pseudo-science.

The presumption is that if G goes up, C will stay unchanged. This ignores any possibility that people will be aware that their taxes are going to go up very dramatically in the future and they will do nothing in response.

The presumption is that the borrowing or printing of money to finance the increase in G will have no effect on aggregate demand.

The presumption is that the people who get the money from the government will spend it rather than save it.

These last points are empirical questions. Actual estimates of the multiplier are all over the map. We don't have a lot of evidence on either side that is reliable. Anecdotal evidence is generally restricted to World War II on the encouraging side and Japan's recent experience on the discouraging side.

I have argued that economists generally came down on one side or the other of the stimulus package based not on their economic understanding but on their political and philosophical biases. I still believe that. I think we're in macroeconomically uncharted territory.Interested viewers might also enjoy this debate between Brad DeLong and Michele Boldrin. Boldrin's also argues that simply increasing G is not sufficient to induce recovery.