The Economist: Long-term deficits: Keynesianism on the Right and the Left

While I haven't yet had the opportunity to get into Keynesian macroeconomic theory or the multiplier effect, The Economist had an article on Keynesianism which was very timely for our current US fiscal policy debates.

Here are a few quotes:

"Mr Wolf thinks the Republicans' "de facto Keynesianism" puts the Democrats at a historic disadvantage, as it's almost impossible to run against a party that constantly promises everyone a free lunch and blames the other guys when the check arrives. He thinks the situation could become disastrous if a Republican win leads to long-term policies so fiscally irresponsible as to flirt with the possibility of a federal default."

One of the things you'll learn in Economics is that our national macro economy does not function or play by the same rules that a household economy does. The national economy with a strong central bank like ours can, and in times of recession should, run national deficits. There are essentially two ways to do that - cut taxes or increase spending. Increasing spending has a more stimulative effect, currently $1.60 for every $1.00 spent, than tax cuts do. It also matters who is paying the taxes and what their marginal propensity to save is, people with more wealth tend to save more and therefore stimulate the economy less.

"Most people have a naive view of money based on the model of the household budget. They're not used to thinking about money as an artificial token of exchange backed by the totality of productive capacity in the economy, whose purpose is to allow people to incentivise others to do useful things for them, such that if an accounting imbalance makes it difficult to pay people to do the useful things they're capable of doing, one way to get them working again might be simply to create more money. "

The article cites several conservative economists like Bruce Barlett of Reagan Era fame, and more liberal economists like nobel prize winner Paul Krugman and Jamie Galbraith. When you have that many economists all agreeing on the same thing, perhaps it is time to listen!

Here is a quote from Wolf's article in the Financial Times:

"The future of fiscal policy was intensely debated in the FT last week. In this Exchange, I want to examine what is going on in the US and, in particular, what is going on inside the Republican party. This matters for the US and, because the US remains the world’s most important economy, it also matters greatly for the world.

My reading of contemporary Republican thinking is that there is no chance of any attempt to arrest adverse long-term fiscal trends should they return to power. Moreover, since the Republicans have no interest in doing anything sensible, the Democrats will gain nothing from trying to do much either. That is the lesson Democrats have to draw from the Clinton era’s successful frugality, which merely gave George W. Bush the opportunity to make massive (irresponsible and unsustainable) tax cuts. In practice, then, nothing will be done.

Indeed, nothing may be done even if a genuine fiscal crisis were to emerge. According to Bruce Bartlett, a highly informed, if jaundiced, observer, some “conservatives” (in truth, extreme radicals) think a federal default would be an effective way to bring public spending they detest under control. It should be noted, in passing, that a federal default would surely create the biggest financial crisis in world economic history.

To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?

How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification – the argument from incentives - for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state.

In this way, the Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage. It also made the Republicans de facto Keynesians in a de facto Keynesian nation. Whatever the rhetoric, I have long considered the US the advanced world’s most Keynesian nation – the one in which government (including the Federal Reserve) is most expected to generate healthy demand at all times, largely because jobs are, in the US, the only safety net for those of working age."

I highly recommend reading both articles in their entirity by clicking on the links below. Also, in order to put this articles in the proper context, keep in mind they are both fairly conservative publications from the UK.


The Political Genius of Supply-Side Economics - Martin Wolf
Long-term Deficits: Keynesianism on the Right and the Left - The Economist