RickJay - I disagree with you. You said, “Your most important function as a member of the economy is not to spend; it’s to WORK.” I disagree on the basis of the definition of an economy. Your statement is a non sequitur. An economy is measured by the amount of money trading hands. You MUST acquire goods and services to have an economy. Your ‘role’ in that is to spend on one hand (acquiring the goods and services) and on the other hand your role is to provide the goods and services (work) FOR MONEY. You must sell your work and, just as importantly, money (to buy your work) must be handed over by spenders. If you work and nobody spends, you have ZERO economic activity. If you have a Utopian society where money is not needed and everyone works for the common good, fine. But when you talk about an ‘economy’, you are talking about a system measured by the movement of money. That, in fact, is why I also disagreed with another comment in this thread. One person said that saving/investing is important. It is more important to get money moving! Investment is nice, working is better, but selling your work (goods and services), and the necessary buying for that to occur, is far and away better!
Economists cannot even explain in consistant detail the mechanisms of things that have already happened. (Let’s not even go into how easy it is to find a “Leading Economist” who will tell you whatever you wish to hear.) They certainly don’t have predictive accuracy greater than tarot cards. (Assuming you don’t accept as predictive accuracy the fact that whatever happens, some economist somewhere predicted that it would happen.)
Keynesian economics comes down to two central points:
A. When an economic bubble bursts, panic hits the market, causing people to stop buying things, stop investing, etc. which causes everything to start to shrink. As markets shrink, people are laid off, which simply makes things even worse.
B. If you give people free money…
[ol]
[li]They will immediately spend it[/li][li]This will grow the market[/li][li]Panic will subside[/li][li]And everything will return to normal[/li][/ol]
Part A is almost certainly true.
No one subsection of B is particularly proven to be true, however. Sometimes the B hypothesis does succeed in the real world, but panic can subside for any number of reasons. Sometimes the B hypothesis may just ruin itself, because the general populace doesn’t have faith that being given free money is financially sound, making market faith decline even further. (And of course, then you have to pay for the stimulus at some point.) Effectively, it all depends on the marketing around the stimulus, rather than the stimulus itself.
Personally, I think the solution to part A is to make the market able to shrink in a non-destructive way. At the moment, as demand drops, wages stay the same. Companies have to scale back, but they can’t lower wages because their workers have loans, mortgages, car payments, rent, etc. that depend on the wage they have. Because most people live to the limit of their wage, they can’t accept a lowered wage. Prices may drop, but most of our debts are guaranteed at a fixed value in a contract which ignores changes to the value of the dollar, and to demand. We need to make contracted values (including wage) rise and fall according to some metric of the market. (Personally, I would vote on corporate revenues, but I suspect that there wouldn’t be a large difference between using that versus the GDP, currency exchange rates, or whatever.)
This is a rather gross oversimplification of how economies work.
At the risk of pointing out the obvious, you and I cannot make each other richer by passing the same $20 bill back and forth. I understand about aggregate demand, the velocity of money, and so forth; I’m not denying that a recession is caused by a dip in demand. But a dip[ in demand is not caused by people suddenly, magically deciding en masse to stop buying big screen TVs; it’s a rational reaction to economic conditions, and it’s the underlying conditions that must be fixed - in the case of the last three years, large scale fiscal conditions.
The creation of wealth means that at some point you must move resources from lower to higher value uses - e.g. you must do work. The demand for good and services will determine what work needs to be done, but it’s work that does it. That’s what makes the economy BIGGER.
If you don’t save and invest, you can’t increase and expand the means of production. I’m not saying demand isn’t part of an economy - of course it is - but the notion that an individual person should feel guilty for not spending enough money is positively goddamned insane. Overspending and personal debt is a serious problem and a major looming crisis, and I find it personally amazing people don’t see that when we just had this problem with respect to spending on houses. People who earn money will use the money one way or another, but overspending means an inevitable correction in spending later.
What’s interesting about this to me is that you say, “why does Keynesian economics tend to fix them?”.
A major point here is that Keynesian solutions haven’t had great success in the world. Most American liberals will point to the Great Depression, yet there is decidely some differences of opinion on that, and certainly a the situation is alot more complicated. Keynes himself did not think it could work in a democracy, and it may not actually be possible even for a very fiscally sound state to borrow enough to satisfy the his more fanatical followers (a la Paul Krugman, who wants to borrow sums that might not even be borrwable).
Even on a world stage, Keynesian solutions for recessions and depressions have had mixed success: mixed as in, we dont’ have a good way to tell if they do much. Unfortunately, studying economies is a lot like trying to study a vast colony of billions of interdependant bacteria. There’s a lot of chemicals going every which way, and we don’t know what most of them do.
Let me tell you the simplified Austrian theory of how recessions happen and what need to be done when they do.
Let’s say the resources of an economy are fully invested, and then there is economic growth. There is demand for the wealth created by this growth, both for investment and consumption purposes. The amount of demand will cause the interest rate to fluctuate, and this represents the time value of that wealth as society sees it. When demand is high, interest rates go up because the money is needed to replenish inventories and hire workers. This causes other uses for the money, such as long-term construction projects, to shrink. People rationally engage in fewer capital intensive or long-term projects, because the new wealth is needed more in other places.
Then when short-term demand falls, interest rates fall. This is the signal that triggers long-term investment. Inventories are high, so the money is more useful elsewhere.
This is the regulatory mechanism by which the market balances all investments that have differing durations and returns on capital. All this is based on real factors of production and the real economy underneath.
But what does the public want when the economy heats up? It wants to keep the party going. Governments deep in debt bask in a shower of new revenue. So it cuts interest rates, or if the Fed doesn’t do what you want you offer tax cuts for interest payments, or tax cuts in general, or free money to achieve the same thing. This screws up the monetary signal. Too much long-term investment is started when the real underlying growth doesn’t support it. Money starts flowing inefficiently. Long-term businesses get started under the assumption that the long-term cost of real wealth is different than it really is.
So, you start getting malinvestments in the economy. A real estate bubble, for example. It represents cheap money flowing into long-term investments. Demand exceeds supply, so house prices go up, which causes people to misjudge their real wealth, and spend inappropriately. Eventually, the real economy asserts itself and the bubble pops. Reality sets in and people realize their wealth was illusory. Long-term projects flounder. Inventories are too high, and people get laid off.
Left alone, this process will shake itself out. The laid off people are available labor. In an ideal world, their wages would fluctuate with demand, so they might fall substantially. But they’d soon enough find work. As capital is freed up from the defunct malinvestments, the price of it falls until investment is attractive. Then the economy starts moving up again as the gaps left by the malinvestments are filled by new enterprises. The economy is now healthier, and poised for faster GDP growth than it experienced before the crash.
However, if interest rates are controlled by a central bank, and the bank responds by inflating the money supply beyond where it should be, it gives the illusion of available resources to long-term investment. This keeps the malinvestments from clearing out of the economy. Businesses that shouldn’t exist are propped up. Government that is too big for the suddenly-smaller real economy doesn’t shrink.
So the fundamental factors that led to the recession in the first place are unchanged - the economy is structured too inefficiently, and needs to be allowed to correct itself, painful though that may be. Attempts to avoid this will result in a perpetual cycle of deficit-fueled double dip recessions or long periods of low growth, while deficits rise until there’s a crisis of confidence, then the whole house of cards comes down.
I think this is too mechanistic of a model. I have a lot of sympathy for some of Keynes’ arguments. Sticky wages are a reality, and they make a difference to the Austrian model. Open markets and fluctuating exchange rates complicate the picture trenemdously, and I’m not sure I understand how. But this is the essence of the Austrian story.
The other Austrian disagreement with Keynes (and other economists, including Friedman) is that economists rely too much on aggregate numbers. Hayek called this ‘Scientistic thinking’ - the desire to put hard numbers and mathematical equations to use, even if it requires treating the complex system of production in the economy as if it was one number that could be fine-tuned and its behavior modeled. Hayek would agree that a fiscal or monetary stimulus would result in some short term gain in output - but that’s exactly why it is damaging. Those idle resources are idle for a reason, and it’s not just fear. Some of them just shouldn’t be there anymore. Some wages are too high given new, lower levels of output, and have to be allowed to be reduced, or job loss will occur. Any stimulus that prevents these necessary changes just spends real wealth to put off the day of reckoning.
I don’t think Hayek and the Austrians had all the answers. Their business cycle theory doesn’t explain recessions before there were central banks. They ignore the real effects of psychology and Keynes’ ‘animal spirits’.
On the other hand, I don’t think Keynes had a sufficient appreciation for the effect of Keynesian solutions on the real economy. I wouldn’t say that the real experience of the stimulus programs that have been going on since 2001 have vindicated Keynes.
However if there is no or little demand for a product, then it gets a lot more difficult for those involved with making the product to make it higher value, since the market is going to depress the price they get for it, and its value will never be higher than what it can be sold for. Now, of course in normal times the answer is to move resources to a product which will be of higher value, but if consumers are cutting back consumption of nearly everything, that gets more difficult.
The solution is to pay workers a fair amount of the value being created through increased productivity. That is exactly what did not happen during the Bush years. The consumption that made the economy look good was created not from the real value you mention but from the fake value of inflated housing prices
If it was just pets.com, a lot of nitwit venture capitalists would have lost money, not the rest of us.
A bigger problem was overbuilding the infrastructure, as people were ordering equipment based on unrealistically rosy scenarios. Making things worse was a fear of shortages and thus making multiple orders for long lead time items. Because contract manufacturers were using just-in-time, they had to build inventory also. In many cases the CMs owned the product until it was shipped, which meant that the nominal owner had less of an incentive to worry about whether the orders were real or not - not that salespeople are in the habit of turning away money.
When the music stopped big companies like Cisco wrote off billions in useless inventory, and the contract manufacturers got hurt even worse. Right after it was hard to sell any hardware because there was so much used stuff out thee, from companies that went belly up. If technological advances hadn’t obsoleted this stuff, the market would still be depressed.
John Maynard Keynes said deficit spending was acceptable during periods of high unemployment, and a decline in per capita gross domestic product (GDP), in order to reduce unemployment and increase economic growth. He also said that during periods of low unemployment and economic growth the national debt should be paid off.
Until 1980 Republicans agreed about paying down the national debt, but thought that deficit spending was only acceptable during war time.
During the Reagan administration Republicans learned that deficit spending nearly always has beneficial effects in the short term. Consequently they cut taxes, blamed the resulting deficits on the Democrats, and took credit for the good economic numbers saying, “Tax cuts work.”
Since then Republicans have been fiscally irresponsible, claiming that it is always a good idea to cut taxes, and never a good idea to raise them.
When Barack Obama was inaugurated in 2009 the national debt as a percentage of GDP was quite a bit higher than it was when Franklin Roosevelt was inaugurated in 1933. This reduces President Obama’s ability to deal with the Great Recession.
Although Vice President Dick Cheney said, “Reagan proved that deficits don’t matter,” Republicans are using the increase in the national debt for which they are responsible in order to wreck the economy with the hope that they can rise from the wreckage and restore laissez faire capitalism.
This prescription was due to Keynes’ assumption that lower consumption was irrational - that fear is causing the economy to overshoot its fundamentals and contract needlessly. The government then acts as a brake on the decline by propping up consumption and restoring confidence, at which point it can remove its stimulus and the economy will come roaring back, and the new GDP growth can then be used to pay off the money borrowed to prevent a deeper recession.
The problem is that this recession is driven mostly by over-leveraging due to a decade-long period in which people consumed more than they should have because the economy was in a bubble. Now that the bubble has popped and trillions of dollars in wealth have been erased from ledgers all over the world, people are rationally reducing consumption and increasing their savings to repair those balance sheets. This is a different situation.
In addition, Keynes never considered the effects of borrowing at a time when one of the main fears driving down the economy is sovereign debt. It’s pretty hard to borrow money to restore confidence when the source of the fear is the fact that you borrow too much money.
In short, the world economy is nothing like what Keynes had dealt with, and the information we have now about how economies respond to large structural debt was not available to Keynes. Nor was the world of Keynes’ time as open as it is now.
You know, the problem with that story is that revenues have not declined as a percentage of GDP - not until the recession. In fact, just before the recession hit government revenue was at an all-time high. In fact, even now the government’s revenue as a percentage of GDP is about what it was in the Carter era.
Under that Dastardly Reagan, who you think started the deficit downhill through tax cuts, total government revenue rose about 3% of GDP to a then-all-time high. Under Clinton’s first administration it stayed relatively flat, then exploded in his second administration due to the tech bubble.
When Bush was elected, Revenue was falling due to the recession. He tried to stop to the recession through a combination of spending and tax cuts (sound familiar?), and the result was a plummeting of revenue from 2001 to 2003. But then the economy and revenue started to recover, and was soon past its all-time high. Of course, a big part of this was the real-estate bubble, just as a big part of Clinton’s gain was due to the tech bubble.
So revenue since 1980 has undergone a whole lot of fluctuations, but until the big crash came, it was not a big driver of the deficit. Cite.
Now, let’s look at government spending, shall we? Chart here. Looking at that chart, you can see what happened. The secret to the Clinton years’ low deficits and ultimately surpluses was that Clinton (with the help of a Republican Congress and Senate) actually decreased the size of government dramatically as a percentage of GDP. Now, he didn’t really decrease it much, other than the ‘peace dividend’, but he didn’t grow it in absolute size at a time when the economy was growing like gangbusters. So GDP grew, and government held constant.
So what caused the big deficits of the 2000’s? Spending. It’s clear as day. The wars in Iraq and Afghanistan helped. The recession of 2001-2003 lowered GDP while government grew, making the ratio go up even faster. Then Bush started pumping money into the federal government on borrowed dollars. He increased discretionary spending dramatically. Then when the crash came, both Bush and Obama doubled down and dramatically increased the size of government as Keynesian stimulus.
If you really want to see the problem, have a look at this chart, which shows government spending in constant dollars, adjusted for the size of the population: Government spending in $2005 dollars, pop. adjusted. Since 1980, in constant dollars, the size of the U.S. government has grown from about $8000 per capita to about $15,000 per capita before the crash. Since then, it’s rocketed up to almost $17,000 per capita. Again, the slowest growth rate of government in absolute terms happened during the two terms of the Clinton administration. But since, it’s been big spender city, by both Obama and Bush.
Spending is the problem. Revenues are down because of the recession, but if it ends it should come back to historical levels. But spending has been growing faster than revenue for a long time, and it really got out of control in the last ten years.
Really? Until now, he hasn’t seemed all that constrained by it. Here’s a chart of U.S. debt: Gross Debt as percentage of GDP. Bush gets no love from me here - after declining under Clinton, Bush put the debt trajectory back on the curve it was on before Clinton, and then added a bit more. But it really takes off under Obama, in a very dramatic way.
Here’s a nice zoom in on the debt from 200 to 2010. As you can see, the amount of debt added by Bush before the crash is absolutely dwarfed by the amount of debt that’s been added since. The combination of rapid revenue loss due to a shrinking economy, coupled with a rapid expansion of government in attempt to counteract the private-sector decline, has created a huge hole in the budget. You simply can’t blame that entirely on the people who came before, since the debt has grown by a huge percentage since just 2007.
If you want to blame the debt on anyone, blame it on Lord Keynes, because that huge ramp-up in debt you see represents Keynesian attempt to control the damage from the recession. The policies of Bush’s last year, which caused the start of that huge run-up in debt, were heartily supported by Barack Obama and all the Keynesian economists (except those who thought even more debt should have been racked up).
You do know that not all Republicans are the same, just as Obama is nothing like Bill Clinton. The ‘Tea Party’ Republicans are just as mad at the old guard Republicans for having let the spending situation get out of control as they are at Democrats, and they’re very serious about the debt and about shrinking the size of government.
Your problem is that you want this problem fixed by raising revenue, and they don’t believe the problem is revenue, but the rapid growth of government. They are opposed to tax increases because they believe that any increase in taxes will simply remove the impetus to cut spending, and the leviathan will continue to grow until it consumes all the new revenue and then demands more. They’ve been burned repeatedly by promises to cut spending if only revenue is raised first. The taxes go up, the cuts never come. So they’ve taken taxes off the table to force the government to get spending under control.
Keynes published his theory in 1937 at a time when most European governments had been driven into default, so your claim here would once again seem to be at significant odds with the facts and the evidence.
Here’s reagan’s former chief econom ist on whether revenues went up or not :
I said “Structural Debt”. The nature of the debts in 1937 were different in that they involved the costs of war and reparations.
Bush had two rounds of tax cuts, in 2001 and 2003. The 2001 tax cuts were Keynesian stimulus, and explicitly sold that way. The idea was to ‘put money in people’s pockets’ so that they would spend it and help the U.S. get out of the recession. It didn’t work. People saved the money instead. The 2003 tax cuts were more ‘supply side’.
But you know, if you keep spending your evenings digging through all of the 20,000+ posts I’ve left on this board over 12 years, I’m sure you can come up with a good ‘gotcha’ one day. I imagine I’ve left inconsistencies here and there. No one’s perfect, and no one stays perfectly consistent with everything they’ve ever done or said. So keep at it, buckaroo.
Economists cannot prove their theories with controlled, repeatable experiments the way physicists and chemists can. We cannot go back to 1932, chose different policies, and measure different results. Nevertheless, as government spending increased during the Roosevelt Administration, unemployment decreased, except for a period following cuts in government spending during 1937.
Those who argue that it was not the New Deal that ended the Great Depression, but the Second World War forget that it was government spending and government employment that ended the Great Depression, and that this paid for by very high taxes on the rich. When the top tax rate reached 94 percent, unemployment declined to 1.2 percent.
Keynes did not say that lower consumption was irrational. If you are out of work you can’t buy very much. If large numbers of people are out of work, it is rational for companies to avoid new investment and hiring. If unemployment is rising, sales are probably falling, so it becomes rational to fire employees, exacerbating the problem. One of Keynes insights is that during a period of high unemployment behavior that is rational on an individual basis is dysfunctional to the larger economy when most people behave that way.
During the 1920s many people consumed too much because of the stock market bubble. This had the same effect as the dot com bubble of the 1990s, and the housing bubble of the Bush administration. People’s houses were worth more, but their wages were not increasing, so they took out home equity loans to make up the difference.
John Maynard Keynes said that deficit spending was acceptable during a period of high unemployment, but he also advocated high taxes on the rich. From 1931 to 1944 the top tax rate rose from 25 percent to 94 percent. From 1932 to 1944 unemployment declined from 23.6 percent to 1.2 percent.
An increase in the top tax rate would make even more sense now than during the Great Depression. Back then everyone lost ground economically. The rich lost during the Stock Market Crash of 1929. Currently, companies are making record profits, even while laying people off.
If Keynes was alive today he would advocate higher business taxes, and higher taxes on the well to do. He would also advocate government jobs programs like the Civilian Conservation Corps and the Works Progress Administration. These would almost certainly have the same salutary effects they had during the 1930s.
Unfortunately, the current governmental emphasis is on reducing government spending without raising taxes on the rather small minority who benefited from the Bush economy. This will almost certainly increase unemployment.
It says “sovereign debt” in your post, not “structural debt.” And you previously described the Bush tax cuts as supply side at a time when you were praising supply side economics, and the Bush tax cuts. Now that supply side economics blew up so badly and you discovered the Austrian cult, the Bush tax cuts become keynesian.
It seems taken for granted that the act of saving extracts from the money supply to the detriment of the economy. Is any consideration ever given to what happens to the money after the savings deposit is made?
Think of a depression as a failure of money to move. The money supply may be there, but it’s not moving. This may be due to a liquidity failure or money supply failure (not enough units of currency freely available to spend); or a lower-income demand failure (not enough persons with money); probably several other possible causes as well.
More spending means a faster, “hotter” economy, and more opportunity to make money. Less spending means a slower, “cooler” economy, & less opportunity to make money. And these can be self-reinforcing cycles, where economic growth spurs more growth, while contraction spurs more contraction.
Keynesian economics takes money from overheated economies (which are inflationary to some degree and can tolerate it) & spends it in sluggish economies (which would grow deflationary without assistance).
This can be done over time: Tax an economy in expansion at a high rate, buying back public debt & perhaps even storing up a rainy day fund–just take in more than you spend. Then spend that fund & perhaps even accrue public debt during a contraction or depression.
But there’s more. One part of the economy may be in expansion while another is depressed. So actually redistributing from very high income persons to low-income persons, while it doesn’t actually make the poor rich, gives the poor more purchasing power, & speeds up the economy. This can be done as a constant policy, & tends to bring the country to a richer level overall, as in the First World in the 20th Century.
(There are environmental costs to a high-consumption economy, but that’s somewhat the case with or without income redistribution.)
Under normal conditions, money which is put into savings is loaned back out or put in as an investment towards some other venture by the bank. During a depression, people are only paying off loans, not taking on new ones, and companies are only paying back dividends, not raising investment money for expansion. The banks would probably love to be able to spend the blocked up cash in their coffers, but they simply don’t have much ability to.