Sunday, July 24, 2011

Why "We Are All Keynesians Now" Has Flopped

Here is a bit from an interesting post by Ezra Klein on his Washington Post blog:
If you ask economists what went wrong during the Great Depression, you’ll often hear: “We hadn’t read Keynes yet.” That’s John Maynard Keynes, author of the “The General Theory of Employment, Interest and Money.” After the crash, his description of economic crises — and how to get out of them — became so widely accepted that, in the 1960s, President Richard Nixon said, “We’re all Keynesians now.”

Well, we’re not all Keynesians now. When you hear “Keynesian” today, it’s usually with “Obamacare” and “socialists.” It’s Republican shorthand not only for the economic theory that governed the Obama administration’s response to the crisis, but also for the general Democratic outlook. And it’s not a compliment.


Keynes — and others who later elaborated on his work, like Hyman Minsky — taught us that although markets are usually self-correcting, they occasionally enter destructive feedback loops in which a shock to, say, the financial system scares business and consumers so badly that they hoard money, which worsens the damage to the system, which further persuades other economic players to hoard, and so on and so forth.

In that situation, the role of the government is to break the cycle. Because businesses and consumers have stopped spending, the government breaks the cycle by spending. As clean as that theory is, it turned out to be a hard sell.

The first problem was conceptual. What Keynes told us to do simply feels wrong to people. “The central irony of financial crises is that they’re caused by too much borrowing, too much confidence and too much spending, and they’re solved by more confidence, more borrowing and more spending,” Summers says.

The second problem was practical. “What I didn’t appreciate was the extent to which we only got one shot on stimulus,” Romer says. “In my mind, we got $800 billion, and surely, if the recession turned out to be worse than we were predicting, we could go back and ask for more. What I failed to anticipate was that in the scenario that we found we needed more, people would be saying that what was happening showed that stimulus, in general, didn’t work.”


But rather than improving on Keynes, the Republican Party has turned against him and the Democratic Party has stopped trying to defend him, much less continue to implement his recommendations.

“The polarization of fiscal policy is one of the worst legacies to come out of the recession,” Romer says, sighing. “Before the crisis, there was agreement that what you do when you run out of monetary tools is fiscal stimulus. Suddenly, it’s like we’re back in the 1930s.”
It is a tragedy. The US is going down the same path as the Japanese after their bank panic in 1989. Their economy has been in a funk for two decades. That is going to be the legacy of the Tea Party and the Republican obstructionists.

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