Posts Tagged ‘Keynes’

It’s not often (actually, only once) that I share a video lasting nearly two hours. But this video – revolving around the intellectual rivalry between pro-market Hayek and pro-intervention Keynes – is an excellent summary of 20th-century economic policy.

We learn about the growth of socialism and communism during and after World War I.

This then led economists from the Austrian school – including Hayek – to explain why that approach (genuine socialism, meaning government ownershipcentral planning, and price controls) was doomed to failure.

But other forms of intervention and redistribution gained new adherents, especially when Keynes argued that the Great Depression was the fault of capitalism (for what it’s worth, I think the video fails to include analysis on how the New Deal actually lengthened and deepened the downturn).

Unfortunately, the Keynesian narrative dominated and the video informs us that the people of the United Kingdom voted for a socialist government when World War II ended. Which then led to the nationalization of the economy’s “commanding heights” and the enactment of the welfare state.

The United States didn’t veer as sharply to the left after the war, but there was no meaningful challenge to the the statist consensus that arose in the 1930s.

On the bright side, Germany rejected socialism by getting rid of price controls and allowing markets to flourish (the video overstated the degree to which a welfare state was imposed). But that was the exception to the rule. The world was gravitating to statism, including the developing world.

My favorite part of the video is that we learn about the creation of the Mont Pelerin Society and the emergence of Milton Friedman and the Chicago School.

That was the start of the laissez-faire counterrevolution. But it didn’t yield immediate results.

The left was in charge of economic policy from the end of the war through the 1970s in the USA and UK, regardless of which political party held power.

But bad policy sooner or later leads to bad results.

And that changed the political environment.

The latter part of the video tells the very happy story on how the sensible ideas of Hayek and Friedman eventually translated into the historic elections of Ronald Reagan and Margaret Thatcher.

If you watch the entire video, you’ll learn about how Reagan and Thatcher successfully overcame major challenges as they shifted their nations toward economic liberty (most notably, Reagan tamed inflation and Thatcher denationalized state-run companies).

And you’ll see that most of the world then followed – including the collapse of the Soviet Empire.

You even get some sympathetic quotes about capitalism from leftists such as Gordon Brown, Larry Summers, and Jeffrey Sachs at the end of the video.

So it seems like a happy ending. And capitalism indeed was the dominant force in economic policy about 20 years ago when the video was released.

Sadly, the track record of the 21st century (Bush II, Obama, and Trump) has not been overly favorable for believers in economic liberty.

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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.

This is the one that got the biggest laugh from me.


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.

And you’ll hopefully learn even more by watching 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.


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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The first entry in this series was an Internet sensation. Now you can enjoy Part II.

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I’m understandably fond of my video exposing the flaws of Keynesian stimulus theory, but here’s another very good contribution to the debate.

This new 5-minute mini-documentary looks at consumer spending and its role in the economy.

Also check out this very popular video from earlier this year on the nightmare of income-tax complexity.

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Warren Buffett once said that it wasn’t right for his secretary to have a higher tax rate than he faced, leading me to point out that he didn’t understand tax policy. The 15 percent tax rates on dividends and capital gains to which he presumably was referring represents double taxation, and when added to the tax that already was paid on the income he invested (and the tax that one imagines will be imposed on that same income when he dies), it is quite obvious that his effective marginal tax rates is much higher than anything his secretary pays. Though he is right that his secretary’s tax rate is much too high. 
Well, it turns out that Warren Buffett also doesn’t understand much about other areas of fiscal policy. Like a lot of ultra-rich liberals who have lost touch with the lives of regular people, he thinks taxpayer anger is misguided. Not only does he scold people for being upset, but he regurgitates the most simplistic Keynesian talking points to justify Obama’s spending spree. Here’s an excerpt from his hometown paper.
Taxpayer anger against President Barack Obama and Congress is counterproductive because policy makers took measures including deficit spending to stimulate the economy, billionaire investor Warren Buffett told CNBC. …“I hope we get over it pretty soon, because it’s not productive,’’ Buffett said. “We will come back regardless of how people feel about Washington, but it is not helpful to have people as unhappy as they are about what’s going on in Washington.” …“The truth is we’re running a federal deficit that’s 9 percent of gross domestic product,” Buffett said. “That’s stimulative as all get out. It’s more stimulative than any policy we’ve followed since World War II.”
About the only positive thing one can say about Buffett’s fiscal policy track record is that he is nowhere close to being the most inaccurate person in the United States, a title that Mark Zandi surely will own for the indefinite future.

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Dana Milbank of the Washington Post wrote this weekend that critics of Keynesianism are somewhat akin to those who believe the earth is flat. He specifically cites the presumably malignant influence of the Cato Institute.

Keynes was right, and in this case it’s probably for the better: Keynes didn’t live to see the Republicans of 2010 portray him as some sort of Marxist revolutionary. …These men get their economic firepower from conservative think tanks such as the Cato Institute… What’s with the hate for Maynard? Perhaps these Republicans don’t realize that some of their tax-cut proposals are as “Keynesian” as Obama’s program. There’s a fierce dispute about how best to respond to the economic crisis — Tax cuts? Deficit spending? Monetary intervention? — but the argument is largely premised on the Keynesian view that government should somehow boost demand in a recession. …With so much of Keynesian theory universally embraced, Republican denunciation of him has a flat-earth feel to it. …There is an alternative to such “Keynesian experiments,” however. The government could do nothing, and let the human misery continue. By rejecting the “Keynesian playbook,” this is what Republicans are really proposing.

Milbank makes some good points, particularly when noting the hypocrisy of Republicans. Bush’s 2001 tax cuts were largely Keynesian in their design, which is also one of the reasons why the economy was sluggish until the supply-side tax cuts were implemented in 2003. Bush also pushed through another Keynesian package in 2008, and many GOPers on Capitol Hill often erroneously use Keynesian logic even when talking about good policies such as lower marginal tax rates.

But the thrust of Milbank’s column is wrong. He is wrong in claiming that Keynesian economics works, and he is wrong is claming that it is the only option. Regarding the first point, there is no successful example of Keynesian economics. It didn’t work for Hoover and Roosevelt in the 1930s. It didn’t work for Japan in the 1990s. It didn’t work for Bush in 2001 or 2008, and it didn’t work for Obama. The reason, as explained in this video, is that Keynesian economic seeks to transform saving into consumption. But a recession or depression exists when national income is falling. Shifting how some of that income is used does not solve the problem.

This is why free market policies are the best response to an economic downturn. Lower marginal tax rates. Reductions in the burden of government spending. Eliminating needless regulations and red tape. Getting rid of trade barriers. These are the policies that work when the economy is weak. But they’re also desirable policies when the economy is strong. In other words, there is no magic formula for dealing with a downturn. But there are policies that improve the economy’s performance, regardless of short-term economic conditions. Equally important, supporters of economic liberalization also point out that misguided government policies (especially bad monetary policy by the Federal Reserve) almost always are responsible for causing downturns. And wouldn’t it be better to adopt reforms that prevent downturns rather than engage in futile stimulus schemes once downturns begin?

None of this means that Keynes was a bad economist. Indeed, it’s very important to draw a distinction between Keynes, who was wrong on a couple of things, and today’s Keynesians, who are wrong about almost everything. Keynes, for instance, was an early proponent of the Laffer Curve, writing that, “Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget.”

Keynes also seemed to understand the importance of limiting the size of government. He wrote that, “25 percent taxation is about the limit of what is easily borne.” It’s not clear whether he was referring to marginal tax rates or the tax burden as a share of economic output, but in either case it obviously implies an upper limit to the size of government (especially since he did not believe in permanent deficits).

If modern Keynesians had the same insights, government policy today would not be nearly as destructive.

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Like a terrible remake of Groundhog Day, the White House has unveiled yet another so-called stimulus scheme. Actually, they have two new proposals to buy votes with our money. One plan is focused on more infrastructure spending, as reported by Politico.
Seeking to bolster the sluggish economy, President Barack Obama is using a Labor Day appearance in Milwaukee to announce he will ask Congress for $50 billion to kick off a new infrastructure plan designed to expand and renew the nation’s roads, railways and runways. …The measures include the “establishment of an Infrastructure Bank to leverage federal dollars and focus on investments of national and regional significance that often fall through the cracks in the current siloed transportation programs,” and “the integration of high-speed rail on an equal footing into the surface transportation program.” 
The other plan would make permanent the research and development tax credit. The Washington Post has some of the details.
Under mounting pressure to intensify his focus on the economy ahead of the midterm elections, President Obama will call for a $100 billion business tax credit this week… The business proposal – what one aide called a key part of a limited economic package – would increase and permanently extend research and development tax credits for businesses, rewarding companies that develop new technologies domestically and preserve American jobs. It would be paid for by closing other corporate tax loopholes, said the official, speaking on condition of anonymity because the policy has not yet been unveiled. 
These two proposals are in addition to the other stimulus/job-creation/whatever-they’re-calling-them-now proposals that have been adopted in the past 20 months. And Obama’s stimulus schemes were preceded by Bush’s Keynesian fiasco in 2008. And by the time you read this, the Administration may have unveiled a few more plans. But all of these proposals suffer from the same flaw in that they assume growth is sluggish because government is not big enough and not intervening enough. Keynesian politicians don’t realize (or pretend not to realize) that economic growth occurs when there is an increase in national income. Redistribution plans, by contrast, simply change who is spending an existing amount of income. If the crowd in Washington really wants more growth, they should reduce the burden of government, as explained in this video.

The best that can be said about the new White House proposals is that they’re probably not as poorly designed as previous stimulus schemes. Federal infrastructure spending almost surely fails a cost-benefit test, but even bridges to nowhere carry some traffic. The money would generate more jobs and more output if left in the private sector, so the macroeconomic impact is still negative, but presumably not as negative as bailouts for profligate state and local governments or subsidies to encourage unemployment – which were key parts of previous stimulus proposals.
Likewise, a permanent research and development tax credit is not ideal tax policy, but at least the provision is tied to doing something productive, as opposed to tax breaks and rebates that don’t boost work, saving, and investment. We don’t know, however, what’s behind the curtain. According to the article, the White House will finance this proposal by “closing other corporate tax loopholes.” In theory, that could mean a better tax code. But this Administration has a very confused understanding of tax policy, so it’s quite likely that they will raise taxes in a way that makes the overall tax code even worse. They’ve already done this in previous stimulus plans by increasing the tax bias against American companies competing in world markets, so there’s little reason to be optimistic now. And don’t forget that the President has not changed his mind about imposing higher income tax rates, higher capital gains tax rates, higher death tax rates, and higher dividend tax rates beginning next January.
All that we can say for sure is that the politicians in Washington are very nervous now that the midterm elections are just two months away. This means their normal tendencies to waste money will morph into a pathological form of profligacy.

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Working in Washington is a frustrating experience for many reasons, but my personal nightmare is that bad ideas refuse to die. Keynesian economics is a perfect example. It doesn’t matter that Keynesian deficit spending didn’t work for Hoover and Roosevelt. It doesn’t matter that it didn’t work for the Japanese all through the 1990s. It doesn’t matter that it didn’t work for Bush in 2008. And it doesn’t matter that it hasn’t worked for Obama. The statists simply shrug their shoulders and say there wasn’t enough spending. Or that the economy would have been even worse with all the so-called stimulus. With this in mind, I was initially excited to read Kevin Hassett’s obituary for Keynesianism, but then I sobered up and realized that evidence is not enough to win this debate. Like a vampire or a Freddy Krueger movie, the bad guy (or bad idea) keeps getting resurrected. So while Kevin’s article is very compelling, I don’t expect that it will stop politicians from doing the wrong thing in the future.

…some Keynesians who supported Barack Obama’s $862 billion stimulus now claim it fell short of their goals not because the idea was flawed, but because the spending package was too small. Christina Romer, the departing chairman of Obama’s Council of Economic Advisers, has become a minor cult hero to the Keynesians, thanks to news reports that said her analysis in 2009 suggested the stimulus should be in the range of $1.2 trillion, or 40 percent larger than it turned out to be. The notion that a much-larger U.S. stimulus would have been more successful isn’t backed up by evidence. Maybe there would be an argument if some countries were now booming because their stimulus packages were larger. Or if some previous U.S. administration had tried a bigger stimulus and had better luck. The fact is, the U.S. stimulus was the largest among members of the Organization for Economic Cooperation and Development, and the biggest ever tried in the U.S. Nor does the academic literature support what we might call these Not-Enough Keynesians. A 2002 study by economists Richard Hemming, Selma Mahfouz and Axel Schimmelpfennig of recessions in 27 developed economies from 1971 to 1998 found that increased spending by government had, in almost all cases, a barely noticeable impact, and sometimes a negative one. Heavily indebted countries that spent more in recessions grew about 0.5 percent less, relative to trend, than countries that didn’t, the study found. …Supporters of this type of stimulus are either unfamiliar with the literature or willing to ignore it. The result is policy that is harmful to our country and inconsistent with modern economic science. If the Obama economic team were medical doctors, they would be pushing the use of medicine not approved by the Food and Drug Administration. As the economic data again head south, it will be much harder to devise successful economic policies because of the budgetary hole that the Keynesians have dug for us. In all likelihood, the data will soon be so convincingly bad that we’ll again debate the need for an economic stimulus. Let’s hope that when that begins, all will finally concede that the ideas of John Maynard Keynes are as dead as the man himself, and that Keynesianism is the real voodoo economics.

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I’m still dealing with the statist echo chamber, having been hit with two additional attacks for the supposed sin of endorsing Reaganomics over Obamanomics (my responses to the other attacks can be found here and here). Some guy at the Atlantic Monthly named Steve Benen issued an critique focusing on the timing of the recession and recovery in Reagan’s first term. He reproduces a Krugman chart (see below) and also adds his own commentary.

Reagan’s first big tax cut was signed in August 1981. Over the next year or so, unemployment went from just over 7% to just under 11%. In September 1982, Reagan raised taxes, and unemployment fell soon after. We’re all aware, of course, of the correlation/causation dynamic, but as Krugman noted in January, “[U]nemployment, which had been stable until Reagan cut taxes, soared during the 15 months that followed the tax cut; it didn’t start falling until Reagan backtracked and raised taxes.”

This argument is absurd since the recession in the early 1980s was largely the inevitable result of the Federal Reserve’s misguided monetary policy. And I would be stunned if this view wasn’t shared by 90 percent-plus of economists. So it is rather silly to say the recession was caused by tax cuts and the recovery was triggered by tax increases.

But even if we magically assume monetary policy was perfect, Benen’s argument is wrong. I don’t want to repeat myself, so I’ll just call attention to my previous blog post which explained that it is critically important to look at when tax cuts (and increases) are implemented, not when they are enacted. The data is hardly exact, because I haven’t seen good research on the annual impact of bracket creep, but there was not much net tax relief during Reagan’s first couple of years because the tax cuts were phased in over several years and other taxes were going up. So the recession actually began when taxes were flat (or perhaps even rising) and the recovery began when the economy was receiving a net tax cut. That being said, I’m not arguing that the Reagan tax cuts ended the recession. They probably helped, to be sure, but we should do good tax policy to improve long-run growth, not because of some misguided effort to fine-tune short-run growth.

The second attack comes from some blog called Econospeak, where my newest fan wrote:

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

Those are some interesting points, and I might respond to them if I wanted to open a new conversation, but they’re not germane to what I said. In my original post (the one he was attacking), I commented on the “burden of government” rather than the “burden of government spending.” I’m a fiscal policy economist, so I’m tempted to claim that the sun rises and sets based on what’s happening to taxes and spending, but such factors are just two of the many policies that influence economic performance. And with regard to my assertion that Reagan reduced the “burden of government,” I’ll defer to the rankings put together for the Economic Freedom of the World Index. The score for the United States improved from 8.03 to 8.38 between 1980 and 1990 (my guess is that it peaked in 1988, but they only have data for every five years). The folks on the left may be unhappy about it, but it is completely accurate to say Reagan reduced the burden of government. And while we don’t yet have data for the Obama years, there’s a 99 percent likelihood that America’s score will decline.

This is not a partisan argument, by the way. The Economic Freedom of the World chart shows that America’s score improved during the Clinton years, particularly his second term. And the data also shows that the U.S. score dropped during the Bush years. This is why I wrote a column back in 2007 advocating Clintonomics over Bushonomics. Partisan affiliation is not what matters. If we want more prosperity, the key is shrinking the burden of government.

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Like the swallows returning to Capistrano, the Congressional Budget Office follows a predictable pattern of endorsing policies that result in bigger government. During the debate about the so-called stimulus, for instance, CBO said more spending and higher deficits would be good for the economy. It then followed up that analysis by claiming that the faux stimulus worked even though millions of jobs were lost. Then, during the Obamacare debate, CBO actually claimed that a giant new entitlement program would reduce deficits. Now that tax increases are the main topic (because of the looming expiration of the 2001 and 2003 tax bills), CBO has done a 180-degree turn and has published a document discussing the negative consequences of too much deficits and debt.
…persistent deficits and continually mounting debt would have several negative economic consequences for the United States. Some of those consequences would arise gradually: A growing portion of people’s savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers; that “crowding out” of investment would lead to lower output and incomes than would otherwise occur. …a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates. …If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation.
At some point, even Republicans should be smart enough to figure out that this game is rigged. Then again, the GOP controlled Congress for a dozen years and failed to reform either CBO or its counterpart on the revenue side, the Joint Committee on Taxation (which is infamous for its assumption that tax policy has no impact on overall economic performance).

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The White House is claiming that the so-called stimulus created between 2.5 million and 3.6 million jobs even though total employment has dropped by more than 2.3 million since Obama took office. The Administration justifies this legerdemain by asserting that the economy actually would have lost about 5 million jobs without the new government spending.
I’ve decided to adopt this clever strategy to spice up my social life. Next time I see my buddies, I’m going to claim that I enjoyed a week of debauchery with the Victoria’s Secret models. And if any of them are rude enough to point out that I’m lying, I’ll simply explain that I started with an assumption of spending -7 nights with the supermodels. And since I actually spent zero nights with them, that means a net of +7. Some of you may be wondering whether it makes sense to begin with an assumption of “-7 nights,” but I figure that’s okay since Keynesians begin with the assumption that you can increase your prosperity by transferring money from your left pocket to your right pocket.
Since I’m a gentleman, I’m not going to share any of the intimate details of my escapades, but I will include an excerpt from an editorial in today’s Wall Street Journal about the Obama Administration’s make-believe jobs.
President Obama’s chief economist announced that the plan had “created or saved” between 2.5 million and 3.6 million jobs and raised GDP by 2.7% to 3.2% through June 30. Don’t you feel better already? Christina Romer went so far as to claim that the 3.5 million new jobs that she promised while the stimulus was being debated in Congress will arrive “two quarters earlier than anticipated.” Yup, the official White House line is that the plan is working better than even they had hoped. We almost feel sorry for Ms. Romer having to make this argument given that since February 2009 the U.S. economy has lost a net 2.35 million jobs. Using the White House “created or saved” measure means that even if there were only three million Americans left with jobs today, the White House could claim that every one was saved by the stimulus. …White House economists…said the unemployment rate would peak at 9% without the stimulus (there’s your counterfactual) and that with the stimulus the rate would stay at 8% or below. In other words, today there are 700,000 fewer jobs than Ms. Romer predicted we would have if we had done nothing at all. If this is a job creation success, what does failure look like? …All of these White House jobs estimates are based on the increasingly discredited Keynesian spending “multiplier,” which according to White House economist Larry Summers means that every $1 of government spending will yield roughly $1.50 in higher GDP. Ms. Romer thus plugs her spending data into the Keynesian computer models and, presto, out come 2.5 million to 3.6 million jobs, even if the real economy has lost jobs. To adapt Groucho Marx: Who are you going to believe, the White House computer models, or your own eyes?

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The fault line in American politics is not really between Republicans and Democrats, but rather between taxpayers and the Washington political elite. Here is a perfect example that symbolizes why economic policy is such a mess. President Bush’s former top aide, Karl Rove, makes the case in the Wall Street Journal that the Obama Administration has been fiscally irresponsible. That’s certainly true, but as I’ve pointed out on previous occasions (here and here), Rove has zero credibility on these issues. In the excerpt below, Rove attacks Obama for earmarks, but this corrupt form of pork-barrel spending skyrocketed during the Bush years. He attacks Obama for government-run healthcare, but Rove helped push through Congress a reckless new entitlement for prescription drugs. He attacks Obama for misusing TARP, but the Bush Administration created that no-strings-attached bailout program. These are examples of hypocrisy, but Rove also is willing to prevaricate. He blames Obama for boosting the burden of government spending to 24 percent of GDP, but it was the Bush Administration that boosted the federal government from 18.2 percent of GDP in 2001 to 24.7 percent of GDP in 2009. Obama is guilty of following similar policies and maintaining a bloated budget, but it was Bush (with Rove’s guidance) that drove the economy into a fiscal ditch.
The president’s problem is largely a mess of his own making. Deficit spending did not begin when Mr. Obama took office. But he and his Democratic allies have supported, proposed, passed or signed and then spent every dime that’s gone out the door since Jan. 20, 2009. Voters know it is Mr. Obama and Democratic leaders who approved a $410 billion supplemental (complete with 8,500 earmarks) in the middle of the last fiscal year, and then passed a record-spending budget for this one. Mr. Obama and Democrats approved an $862 billion stimulus and a $1 trillion health-care overhaul, and they now are trying to add $266 billion in “temporary” stimulus spending to permanently raise the budget baseline. It is the president and Congressional allies who refuse to return the $447 billion unspent stimulus dollars and want to use repayments of TARP loans for more spending rather than reducing the deficit. It is the president who gave Fannie and Freddie carte blanche to draw hundreds of billions from the Treasury. It is the Democrats’ profligacy that raised the share of the GDP taken by the federal government to 24% this fiscal year. This is indeed the road to fiscal hell, and it’s been paved by the president and his party. 

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Nancy Pelosi is being appropriately mocked for her strange assertion that subsidizing unemployment is a great way to “stimulate” the economy, but keep in mind that this she is just mindlessly regurgitating standard Keynesian theory. Here are two videos. The first is Pelosi’s ramblings and the second is my analysis of Keynesian economics. I hope my words are more convincing.

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That’s the title of Richard Rahn’s new column in the Washington Times, which discusses the delusional Keynesian policy being advocated – in America and around the world – by the current administration. As Richard explains, the evidence is overwhelming that government spending does not promote prosperity.
In the face of the unprecedented congressional spending binge, President Obama has been asking Congress to spend even more. Not content with actively promoting the eventual bankruptcy of the United States, Mr. Obama is urging foreign leaders also to increase their government spending – which is truly bizarre. Look at the facts. All of the major European countries have been increasing government spending and deficits at unsustainable rates. The talk for the past couple of months has been about which countries would follow Greece in going over the financial cliff. Responsible economists, financial leaders and, most important, the markets have been telling European leaders they must cut government spending. …The president still seems to believe in the imaginary world of spending multipliers – whereby each dollar of additional spending results in something in the order of $1.40 in additional output. Proponents of such ideas normally refer to themselves as Keynesians (followers of the ideas of John Maynard Keynes, 1883-1946). …The Keynesians and socialists have run hundreds of experiments around the world for the past 70 years, inducing governments to try to spend themselves into prosperity. It doesn’t work. In the 1970s, Keynesian prescriptions led to “stagflation” in the U.S. and many other countries. It was only when Ronald Reagan, Margaret Thatcher and eventually many other leaders (using the ideas of F.A. Hayek and Milton Friedman) reversed course by cutting tax rates and curtailing spending growth that their economies began to grow rapidly without inflation. Mr. Obama seems to have never learned these lessons, and some of his advisers, who once understood what works and what doesn’t, seem to have forgotten. By nature, people like to spend other people’s money, and too many in Congress loved what was billed as Keynesian economic theory because it gave them a rationale to be irresponsible spenders.

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This is another post with a long excerpt, but this editorial from the Wall Street Journal is excellent. I encourage you to click the link and read the whole thing.
…the larger story is the end of the neo-Keynesian economic moment, and perhaps the start of a healthier policy turn. For going on three years, the developed world’s economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity. It hasn’t turned out that way. …The Europeans have had enough and want to swear off the sauce, while the Obama Administration wants to keep running a bar tab. …Like many bad ideas, the current Keynesian revival began under George W. Bush. Larry Summers, then a private economist, told Congress that a “timely, targeted and temporary” spending program of $150 billion was urgently needed to boost consumer “demand.” Democrats who had retaken Congress adopted the idea—they love an excuse to spend—and the politically tapped-out Mr. Bush went along with $168 billion in spending and one-time tax rebates. …enter Stimulus II, with Mr. Summers again leading the intellectual charge, this time as President Obama’s adviser and this time suggesting upwards of $500 billion. When Congress was done two months later, in February 2009, the amount was $862 billion. A pair of White House economists famously promised that this spending would keep the unemployment rate below 8%. Seventeen months later, and despite historically easy monetary policy for that entire period, the jobless rate is still 9.7%. Yesterday, the Bureau of Economic Analysis once again reduced the GDP estimate for first quarter growth, this time to 2.7%, while economic indicators in the second quarter have been mediocre. …this is a far cry from the snappy recovery that typically follows a steep recession, most recently in 1983-84 after the Reagan tax cuts. …The response at the White House and among Congressional leaders has been . . . Stimulus III. While talking about the need for “fiscal discipline” some time in the future, President Obama wants more spending today to again boost “demand.” Thirty months after Mr. Summers won his first victory, we are back at the same policy stand. The difference this time is that the Keynesian political consensus is cracking up. In Europe, the bond vigilantes have pulled the credit cards of Greece, Portugal and Spain, with Britain and Italy in their sights. …The larger lesson here is about policy. The original sin—and it was nearly global—was to revive the Keynesian economic model that had last cracked up in the 1970s, while forgetting the lessons of the long prosperity from 1982 through 2007. The Reagan and Clinton-Gingrich booms were fostered by a policy environment for most of that era of lower taxes, spending restraint and sound money. The spending restraint began to end in the late 1990s, sound money vanished earlier this decade, and now Democrats are promising a series of enormous tax increases. Notice that we aren’t saying that spending restraint alone is a miracle economic cure. The spending cuts now in fashion in Europe are essential, but cuts by themselves won’t balance annual deficits reaching 10% of GDP. That requires new revenues from faster growth, and there’s a danger that the tax increases now sweeping Europe will dampen growth further. …We are told to let Congress continue to spend and borrow until the precise moment when Mr. Summers and Mark Zandi and the other architects of our current policy say it is time to raise taxes to reduce the huge deficits and debt that their spending has produced. Meanwhile, individuals and businesses are supposed to be unaffected by the prospect of future tax increases, higher interest rates, and more government control over nearly every area of the economy. Even the CEOs of the Business Roundtable now see the damage this is doing.

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The Wall Street Journal wisely warns against drawing too many conclusions from one month’s job data, but they also point out that the economy is much weaker than the White House claimed – in large part because of a series of public policy decisions that have rewarded sloth and punished production. Is anyone surprised that the economy’s performance has been tepid?

The private economy—that is, the wealth creation part, not the wealth redistribution part—gained only 41,000 jobs, down sharply from the encouraging 218,000 in April, and 158,000 in March. The unemployment rate did fall to 9.7% from 9.9%, but that was mainly because the labor force contracted by 322,000. Millions of Americans, beyond the 15 million Americans officially counted as unemployed, have given up looking for work. Worst of all, nearly half of all unemployed workers in America today (a record 46%) have been out of work for six months or more. …Whatever happened to the great neo-Keynesian “multiplier,” in which $1 in government spending was supposed to produce 1.5 times that in economic output? …The multiplier is an illusion because that Keynesian $1 has to come from somewhere in the private economy, either in higher taxes or borrowing. Its net economic impact was probably negative because so much of the stimulus was handed out in transfer payments (jobless benefits, Medicaid expansions, welfare) that did nothing to change incentives to invest or take risks. Meanwhile, that $862 billion was taken out of the more productive private economy. Almost everything Congress has done in recent months has made private businesses less inclined to hire new workers. ObamaCare imposes new taxes and mandates on private employers. Even with record unemployment, Congress raised the minimum wage to $7.25, pricing more workers out of jobs. …The “jobs” bill that the House passed last week expands jobless insurance to 99 weeks, while raising taxes by $80 billion on small employers and U.S-based corporations. On January 1, Congress is set to let taxes rise on capital gains, dividends and small businesses. None of these are incentives to hire more Americans. Ms. Romer said yesterday that to “ensure a more rapid, widespread recovery,” the White House supports “tax incentives for clean energy,” and “extensions of unemployment insurance and other key income support programs, a fund to encourage small business lending, and fiscal relief for state and local governments.” Hello? This is the failed 2009 stimulus in miniature.

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Obama and the Democrats are trying to enact a third so-called stimulus (a.k.a., jobs bill). I’d make a joke about three strikes and your out, but we should remember that this is actually the fourth attempt since we should count Bush’s lame faux stimulus in 2008. In any event, one would hope people would learn that borrowing money from the private sector and then squandering it on inefficient and counterproductive programs is not a recipe for economic growth. I was interviewed by Derek Thompson of The Atlantic. Here are a couple of excerpts:

The Keynesian theory is just completely wrong. It didn’t work for Hoover, for FDR, for Japan in the 1990s, for Bush in 2008 or for Obama. Taking money out of your right pocket and putting it in your left pocket doesn’t make sense. We’re wasting money on astoundingly bad ideas, especially by bailing out profligate state governments. It’s better to let the economy run its course than to shovel money at the problem. …recessions are the economy adjusting to previous bad policies. There’s not much you can do. Our economy got way out of whack because of bad policy, and that includes bad monetary policy like easy money from the Federal Reserve.  It’s like a hangover. And the best thing after a hangover position is to not compound the mistake with more drinking. I don’t believe in the hair of the dog theory for getting the economy back on track.

This leads to a rather obvious question. If deficit spending is not stimulus, why are politicians making the same mistake over and over again? The answer, of course, is that politicians will use any excuse to spend money. But there’s another reason for the current orgy of fiscal recklessness. As explained in this video, Obama and the Democrats want to take credit for the economic expansion that eventually will occur. And even if it is a weak recovery because of all the wasteful spending, they can claim the growth occurred because of the so-called stimulus. This makes about as much sense as a rooster crowing and taking credit for the sunrise, but politicians care about spin.

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The politicians in Washington and their enablers in the academy are wildly wrong about how to boost growth. They think more government spending is a key to prosperity, but this blog already has revealed that the Great Depression was made worse because of bigger government. Experts have pointed out that the best way to boost growth is to get government out of the way, as happened in the early 1920s when President Harding allowed the economy to adjust and thus deserves credit for quickly ending a serious downturn. Another great example of the benefits of a laissez-faire approach took place after World War II. The Keynesians all though the Great Depression would resume as government spending was reduced after the war. But as Jason Taylor and Richard Vedder explain for Cato Policy Report, less government spending was exactly the right approach:

….the “Depression of 1946″ may be one of the most widely predicted events that never happened in American history. As the war was winding down, leading Keynesian economists of the day argued, as Alvin Hansen did, that “the government cannot just disband the Army, close down munitions factories, stop building ships, and remove all economic controls.” After all, the belief was that the only thing that finally ended the Great Depression of the 1930s was the dramatic increase in government involvement in the economy. In fact, Hansen’s advice went unheeded. Government canceled war contracts, and its spending fell from $84 billion in 1945 to under $30 billion in 1946. By 1947, the government was paying back its massive wartime debts by running a budget surplus of close to 6 percent of GDP. The military released around 10 million Americans back into civilian life. Most economic controls were lifted, and all were gone less than a year after V-J Day. In short, the economy underwent what the historian Jack Stokes Ballard refers to as the “shock of peace.” From the economy’s perspective, it was the “shock of de-stimulus.” …What happened? Labor markets adjusted quickly and efficiently once they were finally unfettered — neither the Hoover nor the Roosevelt administration gave labor markets a chance to adjust to economic shocks during the 1930s when dramatic labor market interventions (e.g., the National Industrial Recovery Act, the National Labor Relations Act, the Fair Labor Standards Act, among others) were pursued. Most economists today acknowledge that these interventionist polices extended the length and depth of the Great Depression. After the Second World War, unemployment rates, artificially low because of wartime conscription, rose a bit, but remained under 4.5 percent in the first three postwar years — below the long-run average rate of unemployment during the 20th century. …many who lost government-supported jobs in the military or in munitions plants found employment as civilian industries expanded production — in fact civilian employment grew, on net, by over 4 million between 1945 and 1947 when so many pundits were predicting economic Armageddon. Household consumption, business investment, and net exports all boomed as government spending receded. The postwar era provides a classic illustration of how government spending “crowds out” private sector spending and how the economy can thrive when the government’s shadow is dramatically reduced.

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A great column in the Wall Street Journal explains how FDR’s policies hurt the economy. That is true, but the really interesting part of the column for me is that it explains how Roosevelt (and then Truman) were convinced the economy would return to depression after World War II unless there was another giant Keynesian plan. Fortunately, Congress said no. This meant there was no repeat of the Hoover-Roosevelt mistakes of the 1930s and the economy was able to recover and enjoy strong growth:

FDR did not get us out of the Great Depression—not during the 1930s, and only in a limited sense during World War II. Let’s start with the New Deal. Its various alphabet-soup agencies—the WPA, AAA, NRA and even the TVA (Tennessee Valley Authority)—failed to create sustainable jobs. In May 1939, U.S. unemployment still exceeded 20%. European countries, according to a League of Nations survey, averaged only about 12% in 1938. The New Deal, by forcing taxes up and discouraging entrepreneurs from investing, probably did more harm than good. …His key advisers were frantic at the possibility of the Great Depression’s return when the war ended and the soldiers came home. The president believed a New Deal revival was the answer—and on Oct. 28, 1944, about six months before his death, he spelled out his vision for a postwar America. It included government-subsidized housing, federal involvement in health care, more TVA projects, and the “right to a useful and remunerative job” provided by the federal government if necessary. Roosevelt died before the war ended and before he could implement his New Deal revival. His successor, Harry Truman, in a 16,000 word message on Sept. 6, 1945, urged Congress to enact FDR’s ideas as the best way to achieve full employment after the war. Congress—both chambers with Democratic majorities—responded by just saying “no.” No to the whole New Deal revival: no federal program for health care, no full-employment act, only limited federal housing, and no increase in minimum wage or Social Security benefits. Instead, Congress reduced taxes. Income tax rates were cut across the board. …Corporate tax rates were trimmed and FDR’s “excess profits” tax was repealed, which meant that top marginal corporate tax rates effectively went to 38% from 90% after 1945. Georgia Sen. Walter George, chairman of the Senate Finance Committee, defended the Revenue Act of 1945 with arguments that today we would call “supply-side economics.” If the tax bill “has the effect which it is hoped it will have,” George said, “it will so stimulate the expansion of business as to bring in a greater total revenue.” He was prophetic. By the late 1940s, a revived economy was generating more annual federal revenue than the U.S. had received during the war years, when tax rates were higher. Price controls from the war were also eliminated by the end of 1946. …Congress substituted the tonic of freedom for FDR’s New Deal revival and the American economy recovered well. Unemployment, which had been in double digits throughout the 1930s, was only 3.9% in 1946 and, except for a couple of short recessions, remained in that range for the next decade.

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June 12 2020 Addendum: The original video from this post, as you will notice at the end of this column, is no longer on YouTube. So here is a similar video narrated by Professor Art Carden.


Tom Palmer of the Atlas Network has a very concise – yet quite devastating – video exposing the Keynesian fallacy that the destruction of wealth by calamities such as earthquakes or terrorism is good for economic growth. Tom cites the work of Bastiat, who sagely observed that, “There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.” As you can see from the video, many who pontificate about economic matters today miss this essential insight:

I can’t resist the opportunity to also plug a couple of my own videos that touch on the same issues. Here’s one of Keynesian economics, one on the failure of Obama’s faux stimulus, and another on the policies that actually promote prosperity.

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The Congressional Budget Office recently estimated that the so-called stimulus generated jobs and growth. I addressed some of the profound shortcomings in CBO’s Keynesian model in a previous post, pointing out that the model is structured to produce certain results regardless of what happens in the real world. Interestingly, the Director of the CBO, Doug Elmendorf, basically agrees with me. In a recent speech, recorded by C-Span, he was asked during the question-and-answer session whether the model simply spits out pre-determined numbers. After some hemming and hawing and a follow-up question, he confessed “that’s right” when asked if the model would be unable to detect whether the stimulus failed. The relevant exchange begins around the he 39-minute mark of this recording, and Elmendorf’s confession takes place shortly after the 40-minute mark (I selflessly watched the entire thing so you wouldn’t have to suffer waiting for the key moment).

I’m not sure whether this admission is good news or bad news. It is a sign of progress, I suppose, that CBO’s Director is now on the record acknowledging that the model is useless (at least for purposes of measuring the effectiveness of more government spending). But it is perhaps an even more troubling indication of what’s wrong in Washington that nobody is concluding that the time has come to junk Keynesian analysis. This is either an updated version of The Emperor’s New Clothes or a perverse form of the joke about the drunk looking for his keys under the streetlight because there’s light, even though he lost them someplace else.

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When Dorothy and her friends finally reach Oz, they present themselves to the almighty Wizard, only to eventually discover that he is just an illusion maintained by a charlatan hiding behind a curtain. This seems eerily akin to to the state of Keynesian economics. It does not matter that Keynesianism isn’t working for Obama. It does not matter that it didn’t work for Bush, or for Japan in the 1990s, or for Hoover and Roosevelt in the 1930s. In the ultimate triumph of theory over reality, the Keynesians say all that matters is the macroeconomic model behind the curtain showing that more government spending leads to more jobs and growth. Consider the recent report from the Congressional Budget Office (CBO), which claimed that Obama’s stimulus created at least one million jobs. As Brian Riedl of the Heritage Foundation noted:

CBO’s calculations are not based on actually observing the economy’s recent performance. Rather, they used an economic model that was programmed to assume that stimulus spending automatically creates jobs — thus guaranteeing their result. …The problem here is obvious. Once CBO decided to assume that every dollar of government spending increased GDP…, its conclusion that the stimulus saved jobs was pre-ordained.

But surely this can’t be true, you may be thinking. Our public servants in Washington would not make important policy decisions based on a model that automatically produces a certain result, would they? Peter Suderman of Reason pulls aside the curtain:

…those reports rely on assumption-packed models that effectively predetermine their outcomes; what they say, in essence, is that the stimulus worked because we assume it did. …That’s especially true when estimating government spending’s productive effects, which is accomplished by plugging numbers into a formula that assumes that government spending produces a multiplier—an increased return for every government dollar spent. In other words, it extrapolates from how much money is put in rather than from what has actually come out. And it does so using a formula that dictates that if money is put in, even more money will come out. According to the CBO’s estimates, depending on how the money is spent, one dollar of government spending can produce total economic activity of up to $2.50. What a deal! …for all practical purposes, the same multipliers that were used to predict how many jobs would be created are being used to estimate how many jobs have been created.

Interestingly, CBO’s analysis is completely schizophrenic. Its short-run budget numbers are based on free-lunch Keynesianism that assumes deficit-financed government spending boosts growth, while its long-run numbers are driven by an assumption that government borrowing is terrible for growth (which is why CBO actually claims higher taxes boost economic output – see, for example, Figure 3 of this CBO analysis). It is impossible to know whether the people at CBO actually believe their own work, or whether they are simply trying to please their political paymasters by producing results that (conveniently) match up with political preferences for more spending today and higher taxes tomorrow. You can draw your own conclusions, but keep in mind that CBO is now making the absurd claim that a giant new healthcare entitlement will reduce budget deficits.

But I digress. Let’s now give the defense of Keynesian model. The folks at CBO and other Keynesian who publish estimates that inevitably turn out to be wrong (Mark Zandi comes to mind) will claim that they are right because they are predicting results compared to what otherwise would have happened. So when they claim that Obama’s so-called stimulus created jobs, they are really saying that the economy would have lost even more jobs if the government didn’t spend all that money. The problem with this approach is that there is no independent benchmark, but this is not why Keynesianism is wrong. Indeed, most of the economic profession relies on this kind of “counterfactual” analysis. Instead, the problem with Keynesianism is that it fails the empirical test. The Keynesians may be good at constructing models, but that doesn’t mean much if the models don’t match the real world. Here’s what Kevin Hassett of the American Enterprise said in recent congressional testimony:

…most economists learned in graduate school that models like those relied upon most heavily by the CBO provide nonsensical results. The reason the original large scale Keynesian Macro forecasting models were discarded by most of the profession is that they make a simple logical error in assuming that individuals do not change their behavior based on the expectation of future policy. …Professor Barro has been one of the primary contributors to the macroeconomic time series literature that has tried to estimate effects from observed economic data, rather than assume affects, as is done by the Keynesian models. …Barro’s analysis is based on econometric evidence, a reliance on experience. The CBO analysis is based almost exclusively on speculation within the context of Keynesian Macro models that were discredited decisively in the 1970s. …Dating at least back to the seminal work of Nelson (1972), economists have known that the empirical time series approach significantly outperforms macroeconomic models in forecasting competitions. …Ashley (1988) compares data based time series forecasts to those from the large macro forecasters and concludes not only that the time series approach is superior, but that the macro forecasts were so bad that, “most of these forecasts are so inaccurate that simple extrapolation of historical trends is superior for forecasts more than a couple of quarters ahead.” …Finally, one should note that this literature, combined with an earlier public finance literature, raises questions concerning the welfare gain associated with short-term increases in spending. …Browning (1987) finds that the marginal cost ranges widely, between 10% and 300%. Thus, the welfare costs of paying the bill may be greater than the short-term boost to the economy from the most optimistic estimates. This literature would be consistent with Barro’s analysis that suggests the stimulus makes us worse off in the long run.

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To follow up on the post from Saturday, here’s a column by John Lott, which makes the very sensible point that shifting resources from the productive sector of the economy to the government necessarily will cause dislocation in the short run. There also would be inefficiency in the long run, but that’s a separate issue:

…the stimulus created higher unemployment. In fact, my columns in this space predicted that during at the beginning of February 2009 that would be the case. Moving around a trillion dollars from areas where people would have spent it to areas where the government wants to spend it will move a lot of jobs away from those firms that are losing the money to those who are now favored by the government. Since people won’t instantly move from one job to another, there will be a temporary increase in unemployment.

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The Administration is arguing that last year’s $800 billion spending bill has created jobs. But since the unemployment rate is higher and the total number of Americans with jobs has fallen, the White House can only make this claim by arguing that the unemployment rate would be even higher without all the new spending. This argument is seductive to those (such as journalists) who don’t understand that government can’t dump money into the economy without first taking money out of the economy. But there are more reasons why so-called stimulus spending is bad for the economy and job creation. Writing for Investor’s Business Daily, Alan Reynolds of the Cato Institute points out that the recession lasted longer than average and that much of the spending was for programs that subsidize people for not working:

President Obama seized on the one-year anniversary of the American Recovery and Reinvestment Act (ARRA) as an opportunity to take credit for the belated and tenuous economic recovery. But the economy always recovered from recessions, long before anyone imagined that government borrowing could “create jobs.” And we didn’t used to have to wait nearly two years for signs of recovery, as we did this time. A famous 1999 study by Christina Romer, who now heads the Council of Economic Advisers, found the average length of recessions from 1887 to 1929 was only 10.3 months, with the longest lasting 16 months. …The bill was launched last year amid grandiose promises of “shovel ready” make-work projects. In reality, as the CBO explains, “five programs accounted for more than 80% of the outlays from ARRA in 2009: Medicaid, unemployment compensation, Social Security … grants to state and local governments … and student aid.” In other words, what was labeled a “stimulus” bill was actually a stimulus to government transfer payments — cash and benefits that are primarily rewards for not working, or at least not working too hard.

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