OVERSTIMULATED

Part Two:
THE GHOST OF MAYNARD KEYNES

"No one should expect that any logical argument or any experience could shake
the almost religious fervor of those who believe in salvation
through spending and credit expansion.”

Ludwig von Mises,
from "Stones Into Bread: the Keynesian Miracle

During the 2008 State of the Union address on Monday night, President Bush urged Congress to pass his proposed $150 billion fiscal stimulus package. Despite being met with vigorous applause on both sides of the aisle, few have addressed the fact that this package will not make its intended impact, and might even make things worse. Why? It's only a short-term measure, not backed by any long-term removal of the obstacles which impede sustained economic growth. To that effect, the plan is purely Keynesian.

John Maynard Keynes, in his famous (or infamous) treatise General Theory of Employment, Interest & Money, venomously attacked the basic tenets of neoclassical economic theory. According to Keynes, household consumption was the most important component of the economy. When the economy slowed, he asserted, government spending or tax rebates could stimulate either investment or consumption and society could basically spend its way out of recession (sound familiar?). Bush's short-term focus would surely get the approval of Keynes, who once wrote that "in the long run, we are all dead."

Like it or not, Keynes almost single-handedly created the field of macroeconomics. Simply put, the man is a giant. His accuracy may be questioned, but his influence cannot. His fingerprints are found on almost every page of any Econ 101 textbook. But thirty years after Keynes became a worldwide celebrity, a short, funny-looking Jewish guy from Brooklyn named Milton Friedman pointed out one small problem with Keynes: he was wrong, or only partly right at best.

In short, Friedman said that people's consumption patterns are based on health, education, and the income an individual expects over a lifetime. These things do not change dramatically, so consumption is relatively stable. Therefore, short-term solutions like tax rebates aren't likely to have any great effect on economic activity-- especially if the recipient knows that they're only temporary.

When considering these two perspectives in regards to the proposed fiscal stimulus package, a central issue is the marginal propensity to consume. Translating that bit of econo-speak into common English, when people receive their $600 check, how much of it will they use to buy consumer products and how much of it will be devoted to savings? For Keynes' predictions to hold true, people would have to spend more than they save. If they don't, if they save more than they spend, then the package fails to achieve it's stated purpose.

Unfortunately for Keynes and Congress, a recent New York Times poll showed that almost 75% of people receiving rebates would direct the money to debt repayment or to savings, not to increased consumption. What's worse, the Wall Street Journal reports that our tax rebates won't even appear until mid-summer.

But the most damning evidence suggesting that we should hesitate before commencing this political séance of Keynes comes from a study conducted by UC Berkeley's Christina and David Romer. Amidst the recession of the early 1990s, the Romers analyzed policy changes and their effects in eight separate recessions after 1950. They concluded that changes in fiscal policy "have almost always been too small to contribute much to economic recovery."

Over the last few decades, Keynesians and their opponents have waged a knockdown, drag-out slugfest, the intellectual equivalent of Ali-Frasier. And the result? Well, if only in this instance, it seems Keynes has won. Only time will tell if the public shares in his victory.




(Sincere apologies to Mises, Hayek, and the Austrian School, whose brilliant refutations of both Keynesianism and Monetarism have been reluctantly omitted for the sake of brevity and clarity.)