Where are the '60s Hippies Now that They're Needed to Fight Keynesianism?

Keynesian economic theory is the social-science version of a perpetual motion machine. It assumes that you can increase your prosperity by taking money out of your left pocket and putting it in your right pocket. Not surprisingly, nations that adopt this approach do not succeed. Deficit spending did not work for Hoover and Roosevelt is the 1930s. It did not work for Japan in the 1990s. And it hasn't worked for Bush or Obama.

The Keynesians invariably respond by arguing that these failures simply show that politicians didn't spend enough money. I don't know whether to be amused or horrified, but some Keynesians even say that a war would be the best way of boosting economic growth. Here's a blurb from a story in National Journal.

America's economic outlook is so grim, and political solutions are so utterly absent, that only another large-scale war might be enough to lift the nation out of chronic high unemployment and slow growth, two prominent economists, a conservative and a liberal, said today. Nobelist Paul Krugman, a New York Times columnist, and Harvard's Martin Feldstein, the former chairman of President Reagan's Council of Economic Advisers, achieved an unnerving degree of consensus about the future during an economic forum in Washington. ...Krugman and Feldstein, though often on opposite sides of the political fence on fiscal and tax policy, both appeared to share the view that political paralysis in Washington has rendered the necessary fiscal and monetary stimulus out of the question. Only a high-impact "exogenous" shock like a major war -- something similar to what Krugman called the "coordinated fiscal expansion known as World War II" -- would be enough to break the cycle. ...Both reiterated their previously argued views that the Obama administration's stimulus was far too small to fill the output gap.

Two additional comments. First, if Martin Feldstein's views on this issue represent what it means to be a conservative, then I'm especially glad I'm a libertarian. Second, Alan Reynolds has a good piece eviscerating Keynesianism, including a section dealing with Krugman's World-War-II-was-good-for-the-economy assertion.

Obama's Policy Failure, Part I

Former Senator Phil Gramm had a column last week in the Wall Street Journal that deserves two blog posts. This first post highlights Gramm's analysis showing that the U.S. has been very Keynesian compared to Europe, with numerous efforts to jump start the economy with deficit spending. But Senator Gramm hits the nail on the head, comparing America's tepid recovery with the better performance across the Atlantic.

During the average recovery since World War II, gross domestic product (GDP) surpassed the pre-recession high five quarters after the recession began. It has never taken longer than seven quarters. Yet today, after 11 quarters, GDP is still below what it was in the fourth quarter of 2007. The economy is growing at only about a third of the rate of previous postwar recoveries from major recessions. Obama administration officials such as Treasury Secretary Tim Geithner have argued that without their policies the economy would be worse, and we might have fallen "off a cliff." While this assertion cannot be tested, we can compare the recent experience of other countries to our own. ...There are 4.6% fewer people employed in the U.S. today than at the start of the recession. Euro zone countries have lost 1.7% of their jobs. ...This simple comparison suggests...that American economic policy has been less effective in increasing employment than the policies of other developed nations. ...While the most recent quarterly growth figures are just a snapshot in time, it is hardly encouraging that economic growth in the U.S. (1.7%) is lower than in the euro zone (4%), U.K. (4.8%), G-7 (2.8%) and OECD (2%).

Warren Buffett: Good Investor, Crummy Economist

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.

Keynes Was Wrong on Stimulus, but the Keynesians Are Wrong on Just about Everything

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.

Obama's New Stimulus Schemes: Same Song, Umpteenth Verse

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.

New York Times Seeks Higher Taxes on the "Rich" as Prelude to Higher Taxes on the Middle Class

In a very predictable editorial this morning, the New York Times pontificated in favor of higher taxes. Compared to Paul Krugman's rant earlier in the week, which featured the laughable assertion that letting people keep more of the money they earn is akin to sending them a check from the government, the piece seemed rational. But that is damning with faint praise. There are several points in the editorial that deserve some unfriendly commentary.

First, let's give the editors credit for being somewhat honest about their bad intentions. Unlike other statists, they openly admit that they want higher taxes on the middle class, stating that "more Americans — and not just the rich — are going to have to pay more taxes." This is a noteworthy admission, though it doesn't reveal the real strategy on the left. Most advocates of big government understand that it will be impossible to turn America into a European-style welfare state without a value-added tax, but they don't want to publicly associate themselves with that view until the political environment is more conducive to success. Most important, they realize that it will be very difficult to impose a VAT without seducing some gullible Republicans into giving them political cover. And one way of getting GOPers to sign up for a VAT is by convincing them that they have to choose a VAT if they don't want a return to the confiscatory 70 percent tax rates of the 1960s and 1970s. Any moves in that direction, such as raising the top tax rate from 35 percent to 39.6 percent next January, are part of this long-term strategy to pressure Republicans (as well as naive members of the business community) into a VAT trap.

Shifting to other assertions, the editorial claims that "more revenue will be needed in years to come to keep rebuilding the economy." That's obviously a novel assertion, and the editors never bother to explain how and why more tax revenue will lead to a stronger economy. Are the folks at the New York Times not aware that both economic growth and living standards are lower in European nations that have imposed higher tax burdens? Heck, even the Keynesians agree (albeit for flawed reasons) that higher taxes stunt growth.

The editorial also asserts that, "Since 2002, the federal budget has been chronically short of revenue." I suppose if revenues are compared to the spending desires of politicians, then tax collections are - and always will be - inadequate. The same is true in Greece, France, and Sweden. It doesn't matter whether revenues are 20 percent of GDP or 50 percent of GDP. The political class always wants more. But let's actually use an objective measure to determine whether revenues are "chronically short." The Democrat-controlled Congressional Budget Office stated in its newly-released update to the Economic and Budget Outlook that federal tax revenues historically have averaged 18 percent of GDP. They are below that level now because of the economic downturn, but CBO projects that revenues will climb above that level in a few years - even if all of the 2001 and 2003 tax cuts are made permanent. Moreover, OMB's historical data shows that revenues were actually above the long-run average in 2006 and 2007, so even the "since 2002" part of the assertion in the editorial is incorrect.

On the issue of temporary tax relief for the non-rich, the editorial is right but for the wrong reason. The editors rely on the Keynesian rationale, writing that, "low-, middle- and upper-middle-income taxpayers...tend to spend most of their income and the economy needs consumer spending" whereas "Tax cuts for the rich can safely be allowed to expire because wealthy taxpayers tend to save rather than spend their tax savings." I've debunked Keynesian analysis so often that I feel that I deserve some sort of lifetime exemption from dealing with this nonsense, but I'll give it another try. Borrowing money from some people in the economy and giving it to some other people in the economy is not a recipe for better economic performance. Economic growth means we are increasing national income. Keynesian policy simply changes who is spending national income, guided by a myopic belief that consumer spending somehow is better than investment spending. The Keynesian approach didn't work for Hoover and Roosevelt in the 1930s, it didn't work for Japan in the 1990s, and it hasn't worked for Obama. And it doesn't matter if the Keynesian stimulus is in the form of tax rebates. Gerald Ford's rebate in the 1970s was a flop, and George W. Bush's 2001 rebate also failed to boost growth. Tax cuts can lead to more national income, but only if marginal tax rates on productive behavior are reduced so that people have more incentive to work, save, and invest. This is an argument for extending the lower tax rates for all income classes, but it's important to point out that the economic benefits will be much greater if the lower tax rates are made permanent.

Last but not least, the editorial asserts that, "The revenue from letting [tax cuts for the rich] expire — nearly $40 billion next year — would be better spent on job-creating measures." Not surprisingly, there is no effort to justify this claim. They could have cited the infamous White House study claiming that the so-called stimulus would keep unemployment under 8 percent, but even people at the New York Times presumably understand that might not be very convincing since the actual unemployment rate is two percentage points higher than what the Obama Administration claimed it would be at this point.

Why Is Keynesian Economics Like a Freddy Krueger Movie?

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.

The Real Voodoo Economics

When Keynesians Attack, Part II

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.

Obamanomics and my Seven Steamy Nights with the Gals from Victoria's Secret

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?

More Unemployment Is the Key to Stimulus!

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.

Obama's Fiscal Fantasyland

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.

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.

Producers on Strike

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.

Pontificating about the Stupidity of Big-Government Stimulus

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.

Slash Government Spending to Boost Economy

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.

More Garbage-In-Garbage-Out from CBO

You don't need to watch old Gunsmoke episodes if you want to travel into the past. Just read the latest Congressional Budget Office "research" claiming that Obama's so-called stimulus "increased the number of full-time-equivalent jobs by 1.8 million to 4.1 million." CBO's analysis is a throwback to the widely discredited Keynesian theory that assumes you can enrich yourself by switching money from your left pocket to right pocket. For all intents and purposes, CBO wants us to believe their Keynesian model and ignore real world data. This is akin to the famous line attributed to Willie Nelson, who was caught with another woman by his wife and supposedly said, "Are you going to believe me or your lying eyes?"

Using its own Keynesian model, the White House last year said that wasting $800 billion was necessary to keep the unemployment rate from rising above 8 percent. Yet the joblessness rate quickly jumped to 10 percent and remains stubbornly high. We've already beaten this dead horse (here, here, here, here, and here) in part because the White House has embarrassed itself even further with silly attempts to find some way of turning a sow's ear into a silk purse. This is why Obama Administration estimates have evolved from "jobs created" to "jobs saved" to "jobs financed."

The CBO's most recent "calculations" are just another version of the same economic alchemy. But don't believe me. Buried at the end of the report is this passage, where CBO basically admits that its new "research" simply plugged new spending numbers into its Keynesian formula. This sounds absurd, and it is, but don't forget that these are the same geniuses that predicted that a giant new healthcare entitlement would reduce long-run budget deficits.

CBO’s current estimates of the impact of ARRA on output and employment differ slightly from those presented in its February 2010 report primarily because the agency has revised its estimates of ARRA’s impact on federal spending on the basis of new information. Outlays resulting from ARRA in the first quarter of calendar year 2010 were higher than the amount that CBO projected in February 2010 in preparing its estimate of the law’s likely impact on output and employment, primarily because a larger-than-expected amount of refundable tax credits was disbursed in the first quarter rather than later in the year. That change makes the estimated impact of ARRA on output and employment in the first quarter slightly higher than what CBO projected in February.

The New Deal Hurt the Economy

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.

Excellent Video Channeling Bastiat

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.

A Confession from the CBO Director

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.