Free Markets, Free People
Sen. Dick Durbin is an angry man, because he sees the debt deal as the death of Keynesian economics. For some reason, he appears to see this as a bad thing. In his comments today, discussing the debt ceiling deal, he noted:
“I would say … that symbolically, that agreement is moving us to the point where we are having the final interment of John Maynard Keynes,” he said, referring to the British economist. “He nominally died in 1946 but it appears we are going to put him to his final rest with this agreement.”
That’s a bit of hyperbole, but even if true…well…so what?
Lord Keynes had some valuable insight into how fiscal and monetary policy can work inside certain parameters, but outside those parameters, it fails. And I have no doubt whatsoever that even Lord Keynes would recognize that, once a country has accumulated enough debt, the debt itself becomes a drag on economic growth, and attempting to inflate your way out of it by piling on more debt is a solution worse than the disease.
We’ve actually learned quite a lot about how the economy works since the General Theory was published in 1936, not the least of which were the limitations of Keynesian theory in the 1970s. Keynes famously noted that politicians are almost always influenced by the opinions of some long-dead economist. Like John Maynard Keynes.
Keynesian economics should be dead. If nothing else, the existence of stagflation in the 1970s should have shown that Keynsian policy prescriptions were ultimately unworkable. Indeed, the very existence of Stagflation shows that several central tenets of Keynesianism are simply flat wrong. The response to this is usually that the 70s were an aberration due the oil shocks of the Arab Embargo, and the subsequent price hikes enforced by OPEC.
I am, of course, quite well aware of this. I did, after all, live through it.
I am also aware that Keynesianism regarded inflation and recession as being mutually exclusive--an idea that fostered a reliance of the Philips Curve, and constant seeking by the Fed to find the NAIRU. I am further aware that the Fed’s response to the oil shocks was a highly expansionist monetary policy that ultimately kicked off a wage-price spiral in a recession, rather than causing an economic expansion. Apparently, we found the limit at which expansionist policy ceased to be expansionary, and became merely inflationary.
What solved that problem was Paul Volcker’s Fed adopting an explicit Monetarist policy at the Fed to essentially ignore interest rates and concentrate on money supply growth. As hard as it may be to believe now, markets would almost shut down on Thursdays waiting for the M1, M2, and M3 numbers from the Fed. We mostly ignore that Thursday money supply release now. It took a fair amount of pain, and back-to-back recessions in 1981-82 with 11% unemployment to solve the inflation problem, but it did wring inflation out of the economy.
What we learn from all this is that Keynes had some serious policy limitations in the real world. I believe that we are currently discovering more of those limitations.
We’ve actually learned quite a bit about how economies actually work in the 75 years since The General Theory was published. Over the last decade, for instance, a body of peer-reviewed work has been developed (PDF) that shows that an excess of government debt serves as a drag on the economy, shaving at least a full percentage point off of annual GDP growth. And we’ve learned that this negative economic effect has a non-linear effect on economic growth as debt increases. I would submit that in light of this, that no matter how workable Keynesian theory may be in a regime of moderate public debt, with judiciously applied counter-cyclical monetary and fiscal policies, that it simply falls apart as the debt approaches 100% of GDP. One of the key problems is, of course, that we’ve rarely seen the high levels of public indebtedness we’re currently experiencing, so prior to this decade, much of the work in this area was theoretical, except for data from highly indebted emerging countries, which may not be entirely applicable to mature economies.
Sadly, we’re collecting that empirical data now.
I’d also point out that we also don’t have to rely solely on 1970s stagflation to note the failure of Keynesian predictions in the real world. One merely has to look at the wide-spread Keynesian predictions in the immediate Post-WWII era that massive budget cuts to pay down the war debt, coupled with the demobilization of 12 million soldiers, would lead to a return of the US to a depression economy. Of course, no such depression occurred. Quite the opposite, in fact.
It was clear, even a decade after the General Theory was propounded, that it was…incomplete.
One more thing that relates the current level of indebtedness is that attempting to apply Keynes over and over again–but only the deficit spending part–is that, in effect, you’re arguing that the Keynesian solution is to spend, spend, spend, not matter what the level of debt.
There’s simply no evidence at all that even Keynes would have bought into that sort of argument. Indeed, quite the opposite is true. Lord Keynes never argued for increasing public spending as a matter of course, but rather tempering spending with budget-cutting at the appropriate time. Properly applied, even Keynesianism tends towards a balanced budget over time. What we’ve done over the past three decades isn’t Keynesianism, it’s a perversion of it. We’ve spent like drunken sailors attempting to stimulate the economy, but we’ve never actually gotten around to cutting budgets and paying down the debt in the good times. We’ve simply accepted the new level of increased spending as the baseline.
My argument is that we’ve reached beyond the outer bounds where Keynes is applicable. However relevant his observations may be in a regime of limited public debt and counter-cyclical fiscal and monetary policy–which we’ve never really applied by the way, as we’ve ignored the budget-cutting bits–we’ve simply passed the point at which his policy prescriptions can be relied upon, even if they are correct in other contexts.
If Keynesianism is dead, it’s mainly because we’ve killed it.
UPDATE: From Billy Hollis in the comments:
One of the main reasons I have disdain for experts that are part of the political class is the Honors Economics course I took in 1975-76. The professor (an excellent one, and one of the few non-collectivist professors in the department) had us read and contrast John Kenneth Galbraith, who was the leading Keynesian proponent of the time, and Milton Friedman. Galbraith sounded like nonsense to me, and Friedman seemed logical and reasonably clear…
Pumping up the money supply artificially increases demand, trading present good stuff for future bad stuff (inflation, high interest rates, etc.). The only way you can believe that such a technique works in the long term is to assume people are stupid and will fall for the same short term thinking every time you try it.
I’d respond that what JKG called Keynesianism…wasn’t.
Keynes said that in recessions or depressions, the government should use deficit spending to pump more money into the economy. This extra spending would increase the money supply, and stimulate the economy. In addition, the government could cut taxes, allowing people to keep more of what they’d earned.
In good economic times, he said the government should operate at a surplus. That would keep the economy from heating up too fast, and set aside a store of money to be spent in the recessionary times. It would also reduce the money supply, and erase the inflationary pressures bought about by increasing the money supply during the recessions. Taxes could also be raised to help make up the previous budget shortfalls.
So, in a perfect world, the budget would balance, over the course of a business cycle. You’re still trading present good stuff for future bad stuff, but in relatively tiny increments. You really aren’t supposed to do it $14 trillion at a time.
What we had in the 1970s–and since–was half of Keynes. The easy bit. The bit that allowed us to spend, spend, spend, with nary a thought of ever applying fiscal austerity in the good times. Austerity is hard and unpopular. It’s easier just to spend money as a way to buy votes.
Since Keynesianism essentially requires the administration of wise philosopher-kings to administer it, democratically-elected polities have failed at implementing it.
Even more than that, Keynesianism essentially requires the ability to rather precisely target both the timing and amount of stimulus needed to ameliorate a recession, and the timing and amount of austerity to apply in an expansion to wring the expansionary and inflationary pressures out of the economy. But, absent a philosopher king who can operate in synch with the state of the economy, things begin to break down.
Timing the changes in fiscal and monetary policy are, at best, difficult in a democratic state. Messy political deals have to be made and legislation gets held up while waiting for amendments to satisfy some special interest, without which, too few politicians are willing to vote in favor. On the monetary policy side, the effects of policy changes aren’t realized for 8-16 months after a policy change, such as a change in interest rates. And, in either case, no one actually knows what the state of the economy is right now. At best we know what the state of the economy was last month, or three months ago, when the statistics were compiled.
Even at the best of times, with political players of unquestioned integrity, the immense difficulty of knowing the precise timing and amounts of expansionary or contractionary policy that is needed is a daunting task.
Theoretically, Keynes theory is elegant, and explains much about money-based economies. In practice, it’s so difficult and messy to try and implement, and so filled with negative incentives for the politicians who are asked to administer it, that it has simply proven unworkable.
Like communism, the fact that it’s never been properly implemented, or achieved the claimed result, raises serious questions about whether, in the messy world of real people, it ever can be.
Paul Krugman leads the “reaction” brigade with a lament that says cutting government spending while the economy is deeply depressed is a mistake. I have to say, that is not “unexpected”. Krugman has been a one-trick-pony ever since this recession/depression began. Spend, spend, spend – spend more, spend it even if you don’t have it and keep spending until we spend ourselves out of a recession/depression. For most that simply is counter-intuitive.
Krugman also does another thing that is not unexpected. He attempts to blame all of this turbulence on the Republicans while claiming the Democrats got rolled:
It is, of course, a political catastrophe for Democrats, who just a few weeks ago seemed to have Republicans on the run over their plan to dismantle Medicare; now Mr. Obama has thrown all that away. And the damage isn’t over: there will be more choke points where Republicans can threaten to create a crisis unless the president surrenders, and they can now act with the confident expectation that he will.
In the long run, however, Democrats won’t be the only losers. What Republicans have just gotten away with calls our whole system of government into question. After all, how can American democracy work if whichever party is most prepared to be ruthless, to threaten the nation’s economic security, gets to dictate policy? And the answer is, maybe it can’t.
The Republicans called “our whole system of government into question?” No overstatement there. Actually I saw it as more as the Republicans calling attention to the fact that this spending spree and expansion of government intrusion is anathema to “our whole system of government” as first envisioned and then founded. I think what Krugman really means is the GOP has laid claim to the narrative that the current size and cost of government isn’t at all what the founders established and it is time to get back to that vision.
Wow … terrible, huh?
Then there’s the NY Times editorial page. It too laments the deal. More so it laments the fact that Republicans used the crisis to push their election promise to cut spending. Apparently never letting a crisis go to waste only is good for one side. You have to love the phrasing of the editorial – Democrats apparently held out for a few principles while Republicans were simply political barbarians out to loot, plunder, kill and maim (politically speaking, of course):
For weeks, ever since House Republicans said they would not raise the nation’s debt ceiling without huge spending cuts, Democrats have held out for a few basic principles. There must be new tax revenues in the mix so that the wealthy bear a share of the burden and Medicare cannot be affected.
Those principles were discarded to get a deal that cuts about $2.5 trillion from the deficit over a decade. The first $900 billion to a trillion will come directly from domestic discretionary programs (about a third of it from the Pentagon) and will include no new revenues. The next $1.5 trillion will be determined by a “supercommittee” of 12 lawmakers that could recommend revenues, but is unlikely to do so since half its members will be Republicans.
The only somewhat good thing that came out of it, says the NYT, is the ability to continue to spend on entitlements even though we can’t afford them. And note too, the NYT is certainly not for any sort of a balanced budget. And trying to make government smaller, less intrusive, less costly and to have to live within its means makes the Speaker of the House and the rest of the GOPers who committed to all of that “radicals”. Goodness, if that’s how a radical is now defined, count me in.:
Democrats won a provision drawn from automatic-cut mechanisms in previous decades that exempts low-income entitlement programs. There is no requirement that a balanced-budget amendment pass Congress. There will be no second hostage-taking on the debt ceiling in a few months, as Speaker John Boehner and his band of radicals originally demanded. Democratic negotiators decided that the automatic cut system, as bad as it is, was less of a threat to the economy than another default crisis, and many are counting on future Congresses to undo its arbitrary butchering.
Sadly, in a political environment laced with lunacy, that calculation is probably correct. Some Republicans in the House were inviting a default, hoping that an economic earthquake would shake Washington and the Obama administration beyond recognition. Democrats were right to fear the effects of a default and the impact of a new recession on all Americans.
Well of course they were since they were primarily responsible for doubling the national debt in a few years and adding trillions upon trillions of dollars to it. It is they who ran it up against the debt ceiling in record time and now they want to claim that the GOP held the country hostage instead of letting them again have their way with spending money in the trillions of dollars that we don’t have? Balderdash.
Meanwhile, here is how some Democrats reacted:
* Representative Emanuel Cleaver, Democrat of Missouri: “If I were a Republican, this is a night to party,” he said to MSNBC.
* Representative Raul Grijalva, Democrat of Arizona: “This deal trades people’s livelihoods for the votes of a few unappeasable right-wing radicals, and I will not support it. This deal weakens the Democratic Party as badly as it weakens the country,” he added. “We have given much and received nothing in return. The lesson today is that Republicans can hold their breath long enough to get what they want.”
* Representative Nancy Pelosi of California, the Democratic leader: “I look forward to reviewing the legislation with my caucus to see what level of support we can provide.”
* Donna Brazille, Democratic strategist, via Twitter: “Fellow citizens, good night. The debate was one sided – so no winners, no losers. Claim your JOY! No whining because we’re in this together.”
“The GOP won the debate by playing quick & loose w/the truth. Bullyingeveryone, incl media. Stonewalling. Arrogance. This was unnecessary.”
* Robert Reich, former secretary of labor under Bill Clinton, via Twitter: “The heinous deal is preferable to economic catastrophe. The outrage and shame is it has come to this choice.”
“The radical right has won a huge tactical and strategic victory. Democrats have proven they have no tactics and no strategy.”
“It is not the case that ‘both sides’ gave up ’sacred cows.’ Rs linked the debt ceiling to their demand for smaller govt. They’ve got it.”
Got that folks – the “radical right” linked the debt ceiling increase to a demand for smaller government and got it. Isn’t that what they’d said they’d do? Had something like that have occurred on the left, of course, it wouldn’t have been “radical” and people like Reich would be calling it brilliant politics. Of course in this hyper-partisan atmosphere it mostly comes down to whose ox is being gored to understand which side is the radicals are on and which side has the brilliant politicians (well, at least situationaly brilliant).
Some Republican reactions:
* Representative Allen West of Florida: “At this time I believe this is a good plan for the American people.”
* Jon Huntsman, former governor of Utah and presidential candidate: “While some of my opponents ducked the debate entirely, others would have allowed the nation to slide into default and President Obama refused to offer any plan, I have been proud to stand with congressional Republicans working for these needed and historic cuts. A debt crisis like this is a time for leadership, not a time for waiting to see which way the political winds blow.”
* Representative Michele Bachmann of Minnesota, a presidential candidate: “Throughout this process the President has failed to lead and failed to provide a plan. The ‘deal’ he announced spends too much and doesn’t cut enough. This isn’t the deal the American people ‘preferred’ either, Mr. President. Someone has to say no. I will.”
* Representative Connie Mack, Republican of Florida, On MCNBC: “I don’t think the American people are looking for a deal or a compromise, they are looking for a solution to the problem. At the end of the day, I can’t vote for something that is going to ensure that we have over $17 trillion in debt.”
So, reading most of this, it would appear we can safely conclude no one is satisfied with the deal although given the spin coming from both sides, that most think the GOP got most of what it wanted. OK. And the Democrats are supposedly willing, at least for the most part, to sign on.
That’s “compromise” in today’s politics isn’t it? After all, when the “health care crisis” was upon us a little while back, Democrats certainly weren’t at all concerned with compromise or, for that matter, Republicans in general. Now they have to deal with the pesky bastards and their radical brethren and suddenly life is no longer good or simple.
Tsk, tsk (cue world’s smallest violin).
Oh, and I did love this, speaking of trying out a narrative:
The White House is straining to make the case that they’re playing a long-game. David Axelrod: “In the short term, everyone suffers politically. In the long term, I think the Republicans have done terrible damage to their brand. Because now they’re thoroughly defined by their most strident voices.”
Is that right, Mr. Axelrod? Well this little debacle has also “thoroughly defined” the Democrats and the President, and in a most unflattering light. Spendthrifts with no problem whatsoever in piling mountains of debt on future generations being “led” by an empty suit. Yeah, it’s really hurt the Republican brand to actually try to stand up for the principles they were sent to DC to uphold. They won’t be judged as Axlerod would hope they’ll be judged, but instead on how effective they were in accomplishing those principles
The so-called “Budget Control Act of 2011” (assuming both the GOP and Dem caucuses in Congress agree) has the following provisions per Katie Pavlich at Townhall:
* More than $900 billion in deficit reduction over 10 years through discretionary spending caps . $350 billion of that comes from the Pentagon;
* Debt limit increased by at least $2.1 trillion — through 2013…see below for more on how that happens;
* Bipartisan super-committee is tasked with finding $1.5 trillion in deficit reduction by November 23 presumably through tax and entitlement reform. There will be 12 members of the super-committee. House Speaker John Boehner, R-Ohio, House Minority Leader Nancy Pelosi, D-Calif., Senate Majority Leader Harry Reid, D-Nev., and Senate Minority Leader Mitch McConnell, R-Ky., each get to pick three members;
* Congress must vote on recommendations made by the bipartisan Congressional deficit reduction committee by December 23;
* If Congress fails to pass the committee proposal, triggers are enacted that spur at least $1.2 trillion in cuts and those will be close to 50/50 split between domestic/defense spending. But the triggers exempt cuts to Social Security, Medicare beneficiaries and low income programs. The cuts will take effect on January 2, 2013.
So over a third comes from the Pentagon with the remaining two thirds or just less than $600 billion from other discretionary spending. You can ensure that Democratic politicians will try to frame that as granny being pushed over the cliff.
Also note what the “trigger” exempts. As noted then, over 50% or $600 billion in cuts would come from the Pentagon budget and the rest from other discretionary spending. No mandatory spending is touched. That means they can’t use the “I don’t know if [name of favorite government redistribution program here] checks will go out this month” scare tactic. But it also means no serious work will be done on the programs that are killing us – the entitlements. It also means almost a trillion dollars in cuts in defense spending if Congress doesn’t act before December 23 of this year.
Assuming both houses of Congress pass this and Obama signs it, how does it work?
* Immediately after passage of this bill, the president certifies the US government is within $100 billion of hitting the debt ceiling and is given authority to raise the debt ceiling by $400 billion.
* That also triggers a request to increase the debt ceiling by $500 billion — with a process in which Congress can vote to disapprove. The expected outcome: the president vetoes the disapproval, Congress fails to override the veto, and the President is given the authority to raise the debt ceiling by $500 billion.
* The second tranche comes in December. If the super-committee fails to produce a path to reduce the deficit by $1.5 trillion, or Congress fails to pass it, the president makes a request for the authority to raise the debt ceiling by $1.2 trillion. Congress votes to disapprove, the president vetoes it, Congress fails to over-ride the veto, he gets the authority to raise the debt ceiling by $1.2 trillion.
* OR the super-committee succeeds in finding anywhere between $1.2 trillion and $1.5 trillion in deficit reduction and Congress passes it. The president automatically is given the authority to raise the debt ceiling by an equal amount, with no disapproval process.
In the previous cite you saw the make up of the “Super Committee”. Can you really imagine them coming up with all those cuts? My guess is many will be of the Harry Reid variety, where he counted future war spending that we weren’t going to spend.
Also look at the process of raising the debt ceiling. Obama must veto any Congressional disapproval. In a political sense that’s almost as good as having a short term debt ceiling increase to feature during the re-election campaign, because that’s going to come up more than once.
Boehner issued a slide show to put out the GOP’s side of the argument for what they got. One thing not mentioned in Pavlich’s summary is the fact that the bill requires a vote in both the House and Senate on a Balanced Budget Amendment. I’ll just be the first among many to declare that DOA.
Meanwhile the spinmeisters for the President have been busy this morning. More on the politics of all this and reactions in a later post.