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Posts Tagged ‘Keynes’

I don’t know whether to be impressed or horrified by Paul Krugman.

I’m impressed that he’s always “on message.” No matter what’s happening in America or around the world, he always has some sort of story about why events show the need for bigger government.

But I’m horrified that he’s so sloppy with numbers.

My all-time favorite example of his fact-challenged approach deals with Estonia. In an attempt to condemn market-based fiscal policy, he blamed that nation’s 2008 recession on spending cuts that took place in 2009.

Wow. That’s like saying that a rooster’s crowing causes yesterday’s sunrise. Amazing.

Let’s look at a new example. This is some of what he recently wrote while trying to explain why the U.S. has out-performed Europe.

America has yet to achieve a full recovery from the effects of the 2008 financial crisis. Still, it seems fair to say that we’ve made up much, though by no means all, of the lost ground. But you can’t say the same about the eurozone, where real G.D.P. per capita is still lower than it was in 2007, and 10 percent or more below where it was supposed to be by now. This is worse than Europe’s track record during the 1930s. Why has Europe done so badly?

Krugman answers his own question by saying that the United States has been more loyal to Keynesian economics.

…what stands out from around 2010 onward is the huge divergence in thinking that emerged between the United States and Europe. In America, the White House and the Federal Reserve mainly stayed faithful to standard Keynesian economics. The Obama administration wasted a lot of time and effort pursuing a so-called Grand Bargain on the budget, but it continued to believe in the textbook proposition that deficit spending is actually a good thing in a depressed economy.

I have to confess that alarm bells went off in my head when I read this passage.

If Krugman was talking about the two years between 2008 and 2010, he would be right about “staying faithful to standard Keynesian economics.”

But 2010 was actually the turning point when fiscal policy in America moved very much in an anti-Keynesian direction.

Here’s the remarkable set of charts showing this reversal. First, there was zero spending growth in Washington after 2009.

Second, this modest bit of fiscal restraint meant a big reduction in the burden of government spending relative to economic output.

Wow, if this is Keynesian economics, then I’m changing my name to John Maynard Mitchell!

So is Krugman hallucinating? Why is he claiming that U.S. policy was Keynesian?

Let’s bend over backwards to be fair and try to find some rationale for his assertions. Remember, he is making a point about U.S. performance vs. European performance.

So maybe if we dig through the data and find that European nations were even more fiscally conservative starting in 2010, then there will be some way of defending Krugman’s claim.

Yet I looked at the IMF’s world economic outlook database and I crunched the numbers for government spending in the biggest EU economies (Germany, UK, France, Italy, Spain, Netherlands, Sweden, Belgium, accounting for almost 80 percent of the bloc’s GDP).

And what did I find?

Contrary to Krugman’s claims, total government spending in those nations grew slightly faster than it did in the United States between 2009 and 2014.

So on what basis can Krugman argue that the U.S. had a more Keynesian approach?

Beats the heck out of me. I even looked at the OECD data on deficits to see whether there was some way of justifying his argument, but those numbers show the biggest reduction in red ink (presumably a bad thing according to Keynesian stimulus theory) took place in the United States.

But I will close by acknowledging that Krugman’s column isn’t just focused on fiscal policy. He also argues that the Federal Reserve has been more Keynesian than European central banks. My impression is that both the Fed and the ECB have been keeping interest rates artificially low, so I’m not sure that’s an effective argument (or an effective policy!), but I’ll leave that issue to the folks who specialize in monetary policy.

P.S. If you want additional examples of Krugman’s factual errors, see here, here, here, here, here, here, here,here, here, and here.

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I wrote earlier this year about the “perplexing durability” of Keynesian economics. And I didn’t mince words.

Keynesian economics is a failure. It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Japan in the 1990s. And it didn’t work for Bush or Obama in recent years. No matter where’s it’s been tried, it’s been a flop. So why, whenever there’s a downturn, do politicians resuscitate the idea that bigger government will “stimulate” the economy?

And I specifically challenged Keynesians in 2013 to explain why automatic budget cuts were supposedly a bad idea given that the American economy expanded when the burden of government spending shrank during the Reagan and Clinton years.

I also issued that same challenge one day earlier, asking Keynesians to justify their opposition to sequestration given that Canada’s economy prospered in the 1990s when government spending was curtailed.

It seems that the evidence against Keynesianism is so strong that only a fool, a politician, or a college professor could still cling to the notion that bigger government leads to more growth.

Fortunately, it does appear that there’s a growing consensus against this free-lunch theory.

Professor John Cochrane of the University of Chicago (and also an Adjunct Scholar at Cato) has a superb column about the retreat of Keynesianism in today’s Wall Street Journal.

The tide also changed in economic ideas. The brief resurgence of traditional Keynesian ideas is washing away from the world of economic policy. …Why? In part, because even in economics, you can’t be wrong too many times in a row. …Our first big stimulus fell flat, leaving Keynesians to argue that the recession would have been worse otherwise. George Washington’s doctors probably argued that if they hadn’t bled him, he would have died faster. With the 2013 sequester, Keynesians warned that reduced spending and the end of 99-week unemployment benefits would drive the economy back to recession. Instead, unemployment came down faster than expected, and growth returned, albeit modestly. The story is similar in the U.K.

All of this is spot on. Once the stimulus was replaced by spending restraint, the economy did better. And job creation picked up when subsidies for unemployment were limited, just as more sensible economists predicted.

Cochrane is also correct about the spending restraint in the United Kingdom. I didn’t expect Cameron and Osbourne to deliver some good fiscal policy, but it’s happening and the British economy is the envy of most other European nations.

The column also looks at past Keynesian failures.

These are only the latest failures. Keynesians forecast depression with the end of World War II spending. The U.S. got a boom. The Phillips curve failed to understand inflation in the 1970s and its quick end in the 1980s, and disappeared in our recession as unemployment soared with steady inflation.

But this isn’t just about empirical evidence.

I’ve used humor to debunk Keynesianism. Professor Cochrane takes a more high-brow approach to show why the theory doesn’t make sense.

Hurricanes are good, rising oil prices are good, and ATMs are bad, we were advised: Destroying capital, lower productivity and costly oil will raise inflation and occasion government spending, which will stimulate output. Though Japan’s tsunami and oil shock gave it neither inflation nor stimulus, worriers are warning that the current oil price decline, a boon in the past, will kick off the dreaded deflationary spiral this time. I suspect policy makers heard this, and said to themselves “That’s how you think the world works? Really?” And stopped listening to such policy advice. …in Keynesian models, government spending stimulates even if totally wasted. Pay people to dig ditches and fill them up again. By Keynesian logic, fraud is good; thieves have notoriously high marginal propensities to consume.

By the way, just in case you think he’s exaggerating, keep in mind that Paul Krugman actually argued that a fake invasion from outer space would “stimulate” growth because the world would waste money building defenses against E.T.

And Krugman also argued that the 9-11 terrorist attacks were pro-growth!

Cochrane closes with some optimistic thoughts.

…no government in the foreseeable future is going to enact punitive wealth taxes. Europe’s first stab at “austerity” tried big taxes on the wealthy, meaning on those likely to invest, start businesses or hire people. Burned once, Europe is moving in the opposite direction. Magical thinking—that, contrary to centuries of experience, massive taxation and government control of incomes will lead to growth, prosperity and social peace—is moving back to the salons. …the policy world has abandoned the notion that we can solve our problems with blowout borrowing, wasted spending, inflation, default and high taxes. The policy world is facing the tough tradeoffs that centuries of experience have taught us, not wishing them away.

I wish I was equally optimistic about the death of Keynesianism. As I glumly stated a few years ago, Keynesian economics is like a Freddy Krueger move, inevitably rising from the dead when politicians want to rationalize wasting money on favored interest groups.

But I hope Cochrane is right and I’m wrong.

For further information, here’s my video on Keynesian economics.

P.S. Since it’s the holiday season and I’m sharing videos, here’s a very clever and funny video about Keynesian Christmas carols.

The songs in the second half of the video are the ones that make sense, of course, and I particularly like the point that consumer spending is a reflection of growth, not a driver of growth.

P.P.S. If you want even more visual content, here’s the famous video showing the Keynes v. Hayek rap contest, followed by the equally entertaining sequel, which features a boxing match between Keynes and Hayek.

P.P.P.S. But if you want more humor about Keynesian economics, click here, here, here, and here.

P.P.P.P.S. Let’s end on a serious note. It’s encouraging that leaders from nations at opposite ends of Europe are acknowledging the shortcomings of Keynesianism.

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Keynesian economics is a failure.

It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Japan in the 1990s. And it didn’t work for Bush or Obama in recent years.

No matter where’s it’s been tried, it’s been a flop.

So why, whenever there’s a downturn, do politicians resuscitate the idea that bigger government will “stimulate” the economy?

I’ve tried to answer that question.

Keynesian economics is the perpetual motion machine of the left. You build a model that assumes government spending is good for the economy and you assume that there are zero costs when the government diverts money from the private sector. …politicians love Keynesian theory because it tells them that their vice is a virtue. They’re not buying votes with other people’s money, they’re “stimulating” the economy!

I think there’s a lot of truth in that excerpt, but Sheldon Richman, writing for Reason, offers a more complete analysis. He starts by identifying the quandary.

You can’t watch a news program without hearing pundits analyze economic conditions in orthodox Keynesian terms, even if they don’t realize that’s what they’re doing. …What accounts for this staying power?

He then gives his answer, which is the same as mine.

I’d have said it’s because Keynesianism gives intellectual cover for what politicians would want to do anyway: borrow, spend, and create money. They did these things before Lord Keynes published his The General Theory of Employment, Interest, and Money in 1936, and they wanted to continue doing those things even when trouble came of it.

Makes sense, right?

But then Sheldon digs deeper, citing the work of Professor Larry White of George Mason University, and suggests that Keynesianism is popular because it provides hope for an easy answer.

Lawrence H. White of George Mason University, offers a different reason for this staying power in his instructive 2012 book The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years: namely, that Keynes’s alleged solution to the Great Depression offered hope, apparently unlike its alternatives. …White also notes that “Milton Friedman, looking back in a 1996 interview, essentially agreed [that the alternatives to Keynesianism promised only a better distant future]. Academic economists had flocked to Keynes because he offered a faster way out of the depression, as contrasted to the ‘gloomy’ prescription of [F.A.] Hayek and [Lionel] Robbins that we must wait for the economy to self-correct.” …Note that the concern was not with what would put the economy on a long-term sustainable path, but rather with what would give the short-term appearance of improvement.

In other words, Keynesian economics is like a magical weight-loss pill. Some people simply want to believe it works.

Which is understandably more attractive than the gloomy notion the economy has to go through a painful adjustment process.

But perhaps the best insight in Sheldon’s article is that painful adjustment processes wouldn’t be necessary if politicians didn’t make mistakes in the first place!

A related aspect of the Keynesian response to the Great Depression—this also carries on to the current day—is the stunning lack of interest in what causes hard times. Modern Keynesians such as Paul Krugman praise Keynes for not concerning himself with why the economy fell into depression in the first place. All that mattered was ending it. …White quotes Krugman, who faulted economists who “believed that the crucial thing was to explain the economy’s dynamics, to explain why booms are followed by busts.” …why would you want to get bogged down trying to understand what actually caused the mass unemployment? It’s not as though the cause could be expected to shed light on the remedy.

This is why it’s important to avoid unsustainable booms, such as the government-caused housing bubble and easy-money policy from last decade.

Hayek, Robbins, and Mises, in contrast to Keynes, could explain the initial downturn in terms of the malinvestment induced by the central bank’s creation of money and its low-interest-rate policies during the 1920s. …you’d want to see the mistaken investments liquidated so that ever-scarce resources could be realigned according to consumer demand… And you’d want the harmful government policies that set the boom-bust cycle in motion to end.

Gee, what a radical notion. Instead of putting your hope in a gimmicky weight-loss pill, simply avoid getting too heavy in the first place.

For further information, here’s my video on Keynesian economics.

P.S. Here’s some clever humor about Keynesian economics.

P.P.S. If you like humor, but also want some substance, here’s the famous video showing the Keynes v. Hayek rap contest, followed by the equally entertaining sequel, which features a boxing match between Keynes and Hayek. And even though it’s not the right time of year, this satirical commercial for Keynesian Christmas carols is right on the mark.

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It’s sometimes difficult to make fun of Keynesian economics. But this isn’t because Keynesian theory is airtight.

It’s easy, after all, to mock a school of thought that is predicated on the notion that you can make yourself richer by taking money from your right pocket and putting it in your left pocket.

The problem is that it’s hard to utilize satire when proponents of Keynesian theory say things that are more absurd than anything critics could possibly make up.

Paul Krugman, for example, stated a couple of years ago that it would be good for growth if everyone thought the world was going to be attacked by aliens because that would trigger massive military outlays.

He also asserted recently that a war would be very beneficial to the economy.

Equally bizarre, he really said that the terrorist attacks on the World Trade Center would “do some economic good” because of the subsequent money spent on rebuilding.

And let’s not forget that John Maynard Keynes actually did write that it would be good policy to bury money in the ground so that people would get paid to dig it out.

As you can see, it’s difficult to mock such a strange theory since proponents of Keynesianism already have given us such good material.

But let’s try.

Here’s an amusing satirical image of Ludwig von Mises describing Keynesian economics.

Here’s Paul Krugman doing a Keynesian weather report.

This is the one that got the biggest laugh from me, though I’m chagrined at the misspelling.

Keynesian Fire

Last but not least, here’s an image of a neighborhood that has been the recipient of lots of stimulus. I bet the people are very happy.

Sort of reminds me of this satirical Obama campaign poster.

Let’s close with a few serious observations.

I recently added my two cents to the debate in an article debunking the White House’s attempt to justify the failed 2009 stimulus.

And there’s lots of additional material here, here, and here. My favorite cartoon on Keynesian economics also is worth sharing.

But you’ll probably learn just as much and be more entertained by this video from the Atlas Economic Research Foundation. It looks at the left’s fascination with disaster economics.

And here’s my video debunking Keynesian theory.

I’ll end with a gloomy comment. It’s easy to mock Keynesian economics, but it’s very hard to put a stake through its heart.

How can you kill an idea that tells politicians that their vice – buying votes with other people’s money – is actually a virtue?

P.S. Here’s the famous video showing the Keynes v. Hayek rap contest, followed by the equally entertaining sequel, which features a boxing match between Keynes and Hayek. And even though it’s not the right time of year, here’s the satirical commercial for Keynesian Christmas carols.

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Keynesian economics is the perpetual motion machine of the left. You build a model that assumes government spending is good for the economy and you assume that there are zero costs when the government diverts money from the private sector.

With that type of model, you then automatically generate predictions that bigger government will “stimulate’ growth and create jobs. Heck, sometimes you even admit that you don’t look at real world numbers.

Which perhaps explains why Keynesian economics has a long track record of failure. It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Nixon, Ford, and Carter in the 1970s. It didn’t work for Japan in the 1990s. And it hasn’t worked this century for either Bush or Obama.

But politicians love Keynesian theory because it tells them that their vice is a virtue. They’re not buying votes with other people’s money, they’re “stimulating” the economy!

Given this background, you won’t be surprised to learn that Keynesians are now arguing that the recent partial government shutdown hurt growth.

Here’s some of what Standard and Poor’s wrote about that fight and why the shutdown supposedly reduced economic output, along with their warning of economic cataclysm if politicians had been forced to balance the budget in the absence of an increase in the debt ceiling.

…the shutdown has shaved at least 0.6% off of annualized fourth-quarter 2013 GDP growth, or taken $24 billion out of the economy. …the resulting sudden, unplanned contraction of current spending could see government spending cut by about 4% of annualized GDP. That would put the economy in a recession and wipeout much of the economic progress made by the recovery from the Great Recession. …The bottom line is the government shutdown has hurt the U.S. economy.

Part of me wonders whether the bottom line is that S&P was simply looking for an excuse for having made a flawed economic prediction earlier in the year. They basically admit they goofed (though, to be fair, all economists are lousy forecasters), as you can see from this excerpt, but we’re supposed to blame the lower GDP number on insufficient government spending.

In September, we expected 3% annualized growth in the fourth quarter… Since our forecast didn’t hold, we now have to lower our fourth-quarter growth estimate to closer to 2%.

Unsurprisingly, the Obama Administration has been highlighting S&P’s analysis.

A number of private sector analyses have estimated that the shutdown reduced the annualized growth rate of GDP in the fourth quarter by anywhere from 0.2 percentage point (as estimated by JP Morgan) to 0.6 percentage point (as estimated by Standard and Poor’s)… Most of the private sector analyses are based on models that predict the impact of the shutdown based on the reduction in government services over that period.

And the establishment press predictably carried water for the White House, echoing the S&P number. Here’s an example from Time magazine.

The financial services company said the shutdown, which ended with a deal late Wednesday night after 16 days, took $24 billion out of the U.S. economy, and reduced projected fourth-quarter GDP growth from 3 percent to 2.4 percent.

If nothing else, this is a good example of how a number gets concocted and becomes part of the public policy discussion.

Let’s take a step back,however, and analyze whether that $24 billion number has any merit.

The Keynesian interpretation is that the shutdown took money “out of the economy.” According to the theory, money apparently disappears if government doesn’t spend it.

In reality, though, less government spending means that more funds are available in credit markets for private spending. This video explains why Keynesian theory is misguided.

And if you want to dig further into the issue, you can click here for a video that explains why we might get better decisions if policy makers focused on how we earn income rather than how we allocate income.

Now that I’ve shared the basic arguments against Keynesian economics, let me give two caveats.

First, resources don’t get instantaneously reallocated when the burden of government spending is reduced. So I’ve always been willing to admit there could be a few speed bumps as some additional labor and capital get absorbed into the productive sector of the economy.

Second, a nation can artificially enjoy more consumption for a period of time by borrowing from overseas. So if deficit spending is financed to a degree by foreigners, overall spending in the economy will be higher and people will feel more prosperous.

But these caveats aren’t arguments for more spending. The ongoing damage of counterproductive government outlays is much larger and more serious than the transitory costs of redeploying resources when spending is reduced. And overseas borrowing at best creates illusory growth that will be more than offset when the bills come due.

Ultimately, the real-world evidence is probably the clincher for most people. As noted above, it’s hard to find a successful example of Keynesian spending.

Yet we have good evidence of nations growing faster when government outlays are being controlled, including Canada in the 1990s and the United States during both the Reagan years and Clinton years.

And the Baltic nations imposed genuine spending cuts and are now doing much better than other European countries that relied on either Keynesian spending or the tax-hike version of austerity.

P.S. Here’s a funny video on Keynesian Christmas carols. And everyone should watch the famous Hayek v Keynes rap video, as well as its equally clever sequel.

P.P.S. Switching to another topic, we have an encouraging update to the post I wrote last year about an Australian bureaucrat who won a court decision for employment compensation after injuring herself during sex while on an out-of-town trip. Showing some common sense, the Australian High Court just ruled 4-1 to strike down that award.

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Paul Krugman recently argued that a fake threat from space aliens would be good for the economy because the people of earth would waste a bunch of money building unnecessary defenses.

That was a bit loopy, as I noted a few days ago, but other Keynesians also have been making really weird assertions. Obama’s Secretary of Agriculture (another department that shouldn’t exist) just said that food stamps are a great form of stimulus (video at the link, for those who think this can’t possibly be true).

Makes me wonder if they’re having some sort of secret contest for who can say the strangest thing on TV. And if that’s the case, Nancy Pelosi has to be in the running for her claim that you create jobs by subsidizing joblessness.

Appearing on Judge Napolitano’s show, I explained why the Keynesian theory is misguided.

Unfortunately, Keynesians are immune to evidence. No matter how bad an economy does when the burden of government increases, they just point to their blackboard equations and claim things would be even worse without the so-called stimulus.

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While driving home last night, I had the miserable experience of listening to a financial journalist being interviewed about the anemic growth numbers that were just released.

I wasn’t unhappy because the interview was biased to the left. From what I could tell, both the host and the guest were straight shooters. Indeed, they spent some time speculating that the economy’s weak performance was bad news for Obama.

What irked me was the implicit Keynesian thinking in the interview. Both of them kept talking about how the economy would have been weaker in the absence of government spending, and they fretted that “austerity” in Washington could further slow the economy in the future.

This was especially frustrating for me since I’ve spent years trying to get people to understand that money doesn’t disappear if it’s not spent by government. I repeatedly explain that less government means more money left in the private sector, where it is more likely to create jobs and generate wealth.

In recent years, though, I’ve begun to realize that many people are accidentally sympathetic to the Keynesian government-spending-is-stimulus approach. They mistakenly think the theory makes sense because they look at GDP, which measures how national income is spent. They’d be much less prone to shoddy analysis if they instead focused on how national income is earned.

This should be at least somewhat intuitive, because we all understand that economic growth occurs when there is an increase in things that make up national income, such as wages, small business income, and corporate profits.

But as I listened to the interview, I began to wonder whether more people would understand if I used the example of a household.

Let’s illustrate by imagining a middle-class household with $50,000 of expenses and $50,000 of income. I’m just making up numbers, so I’m not pretending this is an “average” household, but that doesn’t matter for this analysis anyway.

Expenses                                                        Income                                  

Mortgage           $15,000                        Wages                $40,000

Utilities               $10,000                        Bank Interest       $1,000

Food                     $5,000                        Rental Income      $8,000

Taxes                  $10,000                        Dividends             $1,000

Clothing               $2,000

Health Care         $3,000

Other                   $5,000

The analogy isn’t perfect, of course, but think of this household as being the economy. In this simplified example, the household’s expenses are akin to the way the government measures GDP. It shows how income is allocated. But instead of measuring how much national income goes to categories such as consumption, investment, and government spending, we’re showing how much household income goes to things like housing, food, and utilities.

The income side of the household, as you might expect, is like the government’s national income calculations. But instead of looking at broad measures of things such wages, small business income, and corporate profits, we’re narrowing our focus to one household’s income.

Now let’s modify this example to understand why Keynesian economics doesn’t make sense. Assume that expenses suddenly jumped for our household by $5,000.

Maybe the family has moved to a bigger house. Maybe they’ve decided to eat steak every night. But since I’m a cranky libertarian, let’s assume Obama has imposed a European-style 20 percent VAT and the tax burden has increased.

Faced with this higher expense, the household – especially in the long run – will have to reduce other spending. Let’s assume that the income side has stayed the same but that household expenses now look like this.

Expenses                                                       

Mortgage           $15,000

Utilities                 $9,000        (down by $1,000)

Food                     $4,000        (down by $1,000)

Taxes                  $15,000        (up by $5,000)

Clothing               $2,000

Health Care         $3,000

Other                   $2,000        (down by $3,000)

Now let’s return to where we started and imagine how a financial journalist, applying the same approach used for GDP analysis,  would cover a news report about this household’s budget.

This journalist would tell us that the household’s total spending stayed steady thanks to a big increase in tax payments, which compensated for falling demand for utilities, food, and other spending.

From a household perspective, we instinctively recoil from this kind of sloppy analysis. Indeed, we probably are thinking, “WTF, spending for other categories – things that actually make my life better – are down because the tax burden increased!!!”

But this is exactly how we should be reacting when financial journalists (and other dummies) tell us that government outlays are helping to prop up total spending in the economy.

The moral of the story is that government is capable of redistributing how national income is spent, but it isn’t a vehicle for increasing national income. Indeed, the academic evidence clearly shows the opposite to be true.

Let’s conclude by briefly explaining how journalists and others should be looking at economic numbers. And the household analogy, once again, will be quite helpful.

It’s presumably obvious that higher income is the best thing for our hypothetical family. A new job, a raise, better investments, an increase in rental income. Any or all of these developments would be welcome because they mean higher living standards and a better life. In other words, more household spending is a natural consequence of more income.

Similarly, the best thing for the economy is more national income. More wages, higher profits, increased small business income. Any or all of these developments would be welcome because we would have more money to spend as we see fit to enjoy a better life. This higher spending would then show up in the data as higher GDP, but the key things to understand is that the increase in GDP is a natural result of more national income.

Simply stated, national income is the horse and GDP is the cart. This video elaborates on this topic, and watching it may be more enjoyable that reading my analysis.

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