The Keynesian Crack-Up

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.