What exactly causes recessions and why does Keynesian economics tend to fix them? How come they were apparently used in our recession but without great effects?
In all honesty, I don’t think that there currently exists concrete answers to those questions. At the moment, there are only competing theories. Unfortunately, the economy is so complex, and economics is such a terribly soft science that it’s very difficult to answer questions of this sort.
Well the second part is easier. Instead of paying down the deficit while times were good, we lowered taxes. That made it more difficult to deficit spend. Essentially the Bush administration did everything opposite what one would expect.
Also, all things being equal, lowering taxes on wealthier individuals took money out of the economy because wealthy people have a lower propensity to spend. Again, pretty much the wrong policy from a Keynesian point of view.
Normally in a time like this we’d spend like hell on domestic projects like highways, dams, and other improvements to infrastructure. But we pretty much have out hands tied because of the crippling amount of debt we are carrying.
My non-professional, amateur understanding. Sadly, I never took any economics in college, so my opinions are just what little I think I know.
Recessions are caused by overinvestments in boom times that then collapse under their own debt, or a lack of spending in the economy for various reasons (insecurity, inflation, stagnant wages, high interest, etc). Keynesian economics involves running deficits either by public works projects or tax cuts (both of which were in the stimulus) and public sector control over bad behavior by business.
Some economists like Roubini and Krugman were saying the stimulus needed to be much bigger, 1-2 trillion. And it should’ve been mostly spending and aid to the poor (who spend the money they are given), with far fewer tax cuts. THe stimulus was about 800 billion and about 1/3 of it was tax cuts. I’ve heard w/o the current stimulus bill the U3 would’ve been closer to 13% instead of the 9-10% it ended up being.
Plus we don’t have public sector control over private abuses. Eliot Spitzer tried to reign in some abuses by mortgage companies but was stopped by the federal government. We live in a cult of deregulation, so that wasn’t realistic.
On another note I theorize a big reason conservatives love the term ‘Keynesian’ now is because it sounds vaguely like ‘Kenyan’, and can be used as a dog whistle double entendre.
The economy naturally oscillates betweem booms and recessions for various reasons. Availability of resources. Weather. Changes in fiscal or monetary policy. Population and demographic changes. Political changes. Technological advances. So on and so forth. It’s simply part of the business cycle.
Keynes theorized that the private sector can cause inefficiencies in the economy and that sometimes government needs to step in to stabalize the economy. Unlike your personal finances, the economy is not necessarily strengthed by balancing the national budget. By spending money and encouraging lending, the government can stimulate economic growth, even if it means short term debt.
Bailout money was used to some effect to prevent a total collapse of the banking system. But the reason growth is still aenemic is that this recession was not caused by normal market fluctuations. It was caused by a systematic correction of the entire economy due to the huge amount of hidden debt overstating the value of assets.
Well, if you’re a Keynesian, what causes recessions is that consumer confidence in the economy gets shaken for whatever reason, and people get nervous about spending money, because they’re scared that hard times are coming. So they start cutting back on purchases and start saving more. Then of course, since you’re saving money, you don’t buy a new TV at my electronics store, and so my income goes down, and I start looking for ways to save money and cut spending and all that. And so the cure for that, for Keynes, is for the government to expand the money supply. You put more money in people’s hands, make it easier for them to borrow money, and people get over their fears and good times are back.
However, Keynes says, sometimes that doesn’t work. Sometimes, even if the government makes it easier to borrow money and expands the money supply, people are still too scared to spend. This is what’s called a “liquidity trap”. In order to get out of the liquidity trap, Keynes said, the government has to take drastic action and start spending money itself. The hope is, this will increase consumer confidence and get people willing to start spending their own money. Keynes called this, “priming the pump”.
In case you’re curious, Milton Friedman and his monetarists had a different answer to what causes recessions, although not an entirely different answer. Friedman argued that recessions aren’t caused by a failure in consumer confidence, but instead by a “liquidity crisis”. They argue that recessions come when the money supply shrinks, and that leads to a shortage of liquid assets. Since there’s insufficient liquidity, banks start failing, which shrinks the money supply further, and nobody has any available money, which leads to economic collapse. So, Friedman said, it’s the government’s job to keep the money supply stable, keep monetary policy loose, keep interest rates low, and act as the lender of last resort to banks who are suffering from liquidity crises. In that view, government spending to “prime the pump”, as Keynes suggested, isn’t very useful.
I’d tell you what the Austrian School thinks, but I’m not entirely sure they do. In more seriousness, the Austrian School, I think, would argue that recessions happen, they’re inevitable, and the government can’t do anything about them, and shouldn’t try, because anything the government does will just prolong it. They don’t believe in liquidity crises at all, really, and so they think that both Keynes and Friedman are falling into the old trap of assuming the economy can be managed; a trap that started, they say, with the formation of the Federal Reserve and the creation of fractional reserve banking itself. But Austrians are depressing pessimists, in my view.
The concept of a liquidity crisis seems to mix with what happened, tons of investment and commercial banks held onto mortgage backed assets that lost trillions in value, which cut liquidity and nobody wanted to loan money to a bank that was overlevereged and had toxic assets as collateral. The TARP bill was supposed to buy all those assets off, but I don’t think the bankes used it for that after getting the money.
But corporate profits are skyrocketing right now, they now have about 2 trillion in cash reserves. The extra money isn’t making the economy move forward. Neither are the low interest rates from the fed.
Also do either Friedman or Keynesian economics take into account international trade (most of their ideas seem to come from a time when nations like Brazil, India, China, etc were poor and not rapidly growing middle income countries)? My impression is that right now some of the profits made in the US (due to the ability to depress wages) are being reinvested overseas and creating jobs there. Won’t that eventually benefit us by creating more consumers for products and services we make here, or will we mostly be bypassed by all that?
Where is the demand going to come from in the US or global economy (the growing consumer class in middle income countries)? That seems to be a big part of what is missing.
The bubble popped. All that wealth was faker than Pamela Anderson’s tits. And people knew it was a bubble many years ago, they just didn’t think they’d be the ones caught without a chair to sit on at the end of the game. People were even talking about it on FARK of all places back in 2002-03. Various people and organizations had an interest in keep the bubble up as long as possible because, well, you see what happens when we don’t have it.
Does anyone else feel almost guilty when reading anything about economics and how important demand is to supporting a modern economy? Because I don’t do my part to buy shiny plastic baubles that break in 6 weeks. If people had my spending habits the economy would be a wasteland.
Sometimes I wonder what our world would be like without Christmas too. Would all that demand even exist anymore or would it be spread out across the rest of the year? We should try to invent more socially compulsory holidays. You know, make everyone do their part, via peer pressure.
I think responses have been mostly correct, including Captain Amazing’s post (even though I was calling him an “amazing poster” just a week ago :smack: 
). But here are some remarks.
You can joke about Christmas, but consumer and business confidence (eagerness to spend) is one of the key factors in economic growth. Government eagerness to spend can also work, especially if the spending is directed intelligently.
To say that “wealth” is “fake” is a topic that would require clarification and debate. The 2000 crash was blamed in part on over-spending on telecom infrastructure. Is that infrastructure undervalued today? I don’t know. There was a housing boom? Is much housing sitting empty today? Again I don’t know. Or perhaps marshmallow is thinking of imagination-based wealth, e.g. paper profits. But it’s the loss of this “imaginary wealth” that has led to the loss of spending confidence so, Pamela Anderson’s tits notwithstanding, I wouldn’t focus on it as a problem today.
Mr. Clark makes a key point. Economic policies internal to one country are diluted, or diffused inappropriately, in today’s global economy. That is why I oppose the FRB QE program – printing new money and passing it out to Wall Street investors who gleefully put it to work in Asia. Much much better would have been for U.S. Government to have put the money to direct use domestically, e.g. as Roosevelt did in the 1930’s. Please remember that Hoover Dam and the two record-setting bridges near San Francisco were all constructed by the can-do American people with public money at the height of the Great Depression. But such spending would need the approval of the Congress.
And as we know now, that Congress is a farcical tragedy beyond words.
The 2000 crash was due to overspending on internet businesses. A great deal of wealth was invested in companies that had little to no business plan other than “go online”. Today, companies that actually produced something of value like Amazon or Yahoo! are still around. Companies that did not like Pets.com soon failed.
And to answer the second question, yes, there is a great deal of housing sitting empty today in many parts of the country.
Wealth can be “fake” such that irrational exhuberance encourages people to purchase assets for far more than they can ever hope to return. Or in the case of the CDO market, outright fraud and incompetence can overstate the worth of entire companies. But people keep buying them and driving the price up so people don’t want to be left out of the party.
The problem is, at some point, the maket for those assets will readjust to their nominal value faster than you can react to it. And it’s usually triggered by some unexpected “black swan event” like Enron, Arther Andersen’s collapse, 9/11, Bernie Madoff and the fall of Bear Sterns or Lehman Brothers.
- I don’t know what you mean by “nominal” value, but the idea that there is some certain value to which markets are sure to readjust, and in a hurry, is IMHO mistaken.
- Even ignoring what you mean by “nominal” value, and whether the comment is true or not, what relevance do you think this has to the discussion? Which asset markets are going to readjust? What economic policy will that foil?
I might have gone for this - at the bare minimum, it would have been a good, visible symbol in distress. The problem is that the government might not even be capable of this anymore. They’d need exemptions from the myriad regulations which restrain it. And that’s not so easy and spending money.
I wasn’t joking at all. Everyone, even poor people, feel significant societal pressure to be good little consumers. It is a crazy phenomenon. But no crazier than what happens the other 11 months. It only seems bizarre because it is intensified and compressed into a short time span.
My social engineering idea already has a name, Hallmark holiday. You can add in diamond engagement rings to the list as well.
If you take it far enough you get an Onion article. But if we can’t say wealth is fake and not grounded in reality then talking about bubbles becomes complicated. The OP made a reference to the most recent recession so I was referring to the housing bubble.
Perhaps I misinterpreted your comment and that of msmith537. The key problem is not the bubble but the almost inevitable letdown where prices may overshoot in the opposite direction. But to blame present problems on the earlier bubbles is to not look forward. A small bubble would be good right now, if that bubble were to make American consumers more confident of their job outlook, of their retirement security, etc.
Two decades ago, I was already an advocate of considering also asset price inflation when setting interest rates. I hoped Greenspan was on my side there when he cautioned about “irrational exuberance” but he then transmogrified into one of the most irrationally exuberant cheerleaders of all.
But that was then. No one is advocating that the U.S. Government fashion another major price bubble today. (Traditional Republicans might work toward that aim, but they’re not even running their own asylum anymore.) I ask again, what price “bubble” are we worried about now such that that discussion has relevance? Is this just a reference to the platinum trillion-dollar coin (which obviously is minted with a lot less than $1,000,000,000,000 worth of platinum).
Summary: I’m not clear what relationship is implied between “Keynesian economics” and “bubbles” or “fake wealth”, but none of this seems relevant to the 2011 economy. We need some exuberance now, rational or otherwise.
No, it wouldn’t. If everyone had your spending habits then by definition they’d be fine. If you don’t want X, the inability to purchase X is irrelevant to your personal utility.
Consumer spending keeps the wheels greased but it’s not the source of wealth. Investment is what creates wealth; consumer spending is what motivates its creation.
You contradict yourself, in fact. The problem is not that people aren’t spending enough; the problem is that our expectations of what constitutes a normal level of consumer spending were dramatically inflated by the accumulation of huge amounts of debt. People were spending money they didn’t actually have; now the economy has corrected and people are spending the money they actually have. The economy will, eventually, grow to the point that people spent as much as they did in 2003; they just won’t be doing it with overextended credit.
The idea that you can improve the economy by encouraging mass consumer spending is, quite obviously, what got us into this mess in the first place. What you want is stability, not runaway spending. Programs and policies designed to encourage overspending are the very reason we’re in this fucking mess.
The basis behind Keynesian thinking (on this subject) is stability; the idea that the levers of government can keep economic activity relatively level over time.
As to whether or not anyone else feels guilty about not spending money… ha ha, that’s a joke, right? People don’t seriously feel guilty about saving their money, do they? If so I must be some kind of fiscal sociopath.
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It was people spending too much money that caused this damned recession.**
Krugman explains: The Unofficial Paul Krugman Web Page
What causes recessions:
Expectations, just likes booms.
Fundamentally, people trade goods for goods, money is a very convenient (i.e.:transaction-cost reducing) way of doing it. But money can have quirks.
Money can go into three places: investment, consumption and savings. Typically, savings roughly equal investment.
When more people start getting apprehensive, they reduce investment and consumption and increase savings.
This can cause aggregate demand to go below aggregate supply. This reinforces negative expectations which makes it so that more people don’t consume or invest because they fear for the future even though it would be to their advantage to complete that trade.
When a lot of people are holding on to their money such that negative expectations are self-reinforcing, it’s called a liquidity trap.
This might not be that much of a problem if wages went down with expectations but wages very seldom go down. People usually think of their wages in nominal (non-inflation/deflation-adjusted) rather than real (deflation/inflation-adjusted) terms. This opposition to nominal wage cuts to adjust to the recession can make it unappealing for businesses to hire or not fire people.
What you want is for aggregate demand to be a few percentage points above aggregate supply. You don’t want it low because you risk a liquidity trap. You don’t want it high because high and volatile inflation makes it difficult to plan.
“why does Keynesian economics tend to fix them?”
Aggregate demand is made up of consumpton + investment + gov’t spending + (export-imports).
If aggregate demand is below aggregate supply and you have a liquidity trap because investment and consumption are down, the State can increase gov’t spending until aggregate demand is a few percentage points above aggregate supply. This can counter negative expectations and eliminate the liquidity trap.
Also, remember how people think of their wages in nominal rather than real terms? If the gov’t increases inflation significantly, nearly everyone takes a pay cut and most can’t realize it. This allows for real wages to go down to adjust to the recession and for hiring to go correspondingly up.
I don’t know enough about the Keynesian policies used in the last US recession and to what extent they were Keynesian to comment.
Yeah, but the makers of X wouldn’t have a job. There wouldn’t even be an industry.
I certainly agree that people shouldn’t take out loans to make huge purchases for dumb reasons. That doesn’t really impact whether introducing new irrational desires could be beneficial. That’s pretty much the point of advertising, just that it’s done in a more focused way.
If you disagree, do you think it would make any economic sense to try to destroy an industry you don’t like for whatever arbitrary reason? Pick whatever low hanging fruit you want – celebrity gossip rags, psychics, romance novels, sports, whatever. Obviously people like these things and spend tons of money on them. But if you could convince consumers, through a campaign or whatever, that these were actually stupid wastes of time and money then hundreds of thousands to millions of people would lose their jobs. That would be bad. Right?
If it is bad, then why wouldn’t it be good to make another?
If it wouldn’t be bad, then I’m lost. Unless you think everyone is going to retrain into a sales consultant or hair dresser or whatever.
I thought the ultimate goal of any (useful) economics theory was to maintain growth forever and ever, amen, like Edward Abbey’s pithy cancer quote.
I try to stay nimble in these discussions; there are viewpoints which differ, yet still both have validity. But this is just plain wrong.
I’d ask you to clarify whether the spendings you disapprove of include the 1990’s tech stock bubble, the housing bubble soon after, consumer goods in general, foreign wars, or what. If foreign wars are your key example, I might agree with you (real lives, manpower, capital, etc. have been utterly wasted), but for any of the others I’ll call “Cite?”
True the boom of the 1990’s was followed by an inevitable, if smallish, bust. But lowered income during the bust period more or less compensated for higher income during the boom. At worst that’s a wash and if you check the numbers you’ll find the boom added more income (or “product”) than the bust detracted. I’m not arguing “Bubbles are good”, just that the tech-stock bust was of almost irrelevant size – the Enron scandal at about the same time can be regarded as a more significant episode, at least as a presage of what was to come.
The housing bubble ended up a much worse problem but there the problem was less the price-bubble itself, but more the corruption associated (both as causes and effects) of that bubble.
So. I think you’re wrong RickJay. Specify which “people spending too much money” caused this recession, and I’ll argue more specifically.
But again, if EVERYONE had your spending habits, people wouldn’t need jobs that paid as much. If I wanted half as much I could work half as much, or work at a job that paid half as much. You aren’t hurting people by not spending your money like a drunken sailor.
You can’t spend your way to prosperity. Your most important function as a member of the economy is not to spend; it’s to WORK. Wealth is created by moving assets from lower to higher value uses. The free market - consumers - determines what wealth should be created and what prices things should be, but it’s not buying stuff that creates the wealth. It’s designing, marketing, making, and transporting the stuff that gets bought.
This isn’t to say that Keynesian theory is wrong. It’s right; when aggregate demand slips below aggregate supply, you get a recession, and the government can make up for that with increased spending (it helps, though, if the government is smart enough to cut spending in good times, which it rarely is, which is the problem with Keynesian theory in the real world.) But it’s sure as hell not your job to spend money in a way that doesn’t benefit you. If you spend money irrationally… well, that’s what people have been doing, and we now have a phenomenally indebted society, in terms of personal debt.
No. Well, not necessarily.
What you’re describing is effectively what advertising does NOW, and yet you aren’t saying we should stop advertising. If Apple advertises iPhones, and convinces people to spend money on iPhones, then jobs are being created making and selling iPhones but are being lost in whatever industry isn’t getting the money it would have gotten had there been no iPhones.
If I could convince people to stop spending their money on psychics the psychics would lose their jobs, but people would spend their money on some other diversion, and those industries would benefit from the increased revenue.
An interesting example would be pro sports strikes, like the one that ended the Major League Baseball season in 1994 or the one that completely eliminated an NHL season. The result was, rather unsurprisingly, that other local entertainment options saw a boom in revenue.
That’s not to say some utility isn’t lost there - I was certainly sad there was no baseball in 1994 - but it’s not like that money just vanishes.
Now, if I were to become king and interfere in the market by, say, banning smartphones, I’d be destroying wealth. Clearly, you can destroy wealth, through interference in the market or just by destroying things. You cannot improve the economy by breaking windows to create work for glaziers.
No, the purpose of economics theory is to describe the world we live in. Economics is a science. Its purpose is to explore hypotheses, come up with theories, and eventually reveal truths about the nature of economics.
I guess I just don’t agree that you can separate those things.
I’d agree the tech boom (for example) far exceeded in value the following bust. That’s just the nature of our economy; six steps forward, two or three back.
But the housing bubble appears to be a horse of a different colour, and it’s not just a matter of corruption; you cannot deny the U.S. has extraordinarily serious debt problems at all levels of government and in terms of personal debt load.