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.

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.

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?

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.

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.

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.

Keynesian Economics and the Wizard of Oz

When Dorothy and her friends finally reach Oz, they present themselves to the almighty Wizard, only to eventually discover that he is just an illusion maintained by a charlatan hiding behind a curtain. This seems eerily akin to to the state of Keynesian economics. It does not matter that Keynesianism isn't working for Obama. It does not matter that it didn't work for Bush, or for Japan in the 1990s, or for Hoover and Roosevelt in the 1930s. In the ultimate triumph of theory over reality, the Keynesians say all that matters is the macroeconomic model behind the curtain showing that more government spending leads to more jobs and growth. Consider the recent report from the Congressional Budget Office (CBO), which claimed that Obama's stimulus created at least one million jobs. As Brian Riedl of the Heritage Foundation noted:

CBO’s calculations are not based on actually observing the economy’s recent performance. Rather, they used an economic model that was programmed to assume that stimulus spending automatically creates jobs — thus guaranteeing their result. ...The problem here is obvious. Once CBO decided to assume that every dollar of government spending increased GDP..., its conclusion that the stimulus saved jobs was pre-ordained.

But surely this can't be true, you may be thinking. Our public servants in Washington would not make important policy decisions based on a model that automatically produces a certain result, would they? Peter Suderman of Reason pulls aside the curtain:

...those reports rely on assumption-packed models that effectively predetermine their outcomes; what they say, in essence, is that the stimulus worked because we assume it did. ...That's especially true when estimating government spending's productive effects, which is accomplished by plugging numbers into a formula that assumes that government spending produces a multiplier—an increased return for every government dollar spent. In other words, it extrapolates from how much money is put in rather than from what has actually come out. And it does so using a formula that dictates that if money is put in, even more money will come out. According to the CBO's estimates, depending on how the money is spent, one dollar of government spending can produce total economic activity of up to $2.50. What a deal! ...for all practical purposes, the same multipliers that were used to predict how many jobs would be created are being used to estimate how many jobs have been created.

Interestingly, CBO's analysis is completely schizophrenic. Its short-run budget numbers are based on free-lunch Keynesianism that assumes deficit-financed government spending boosts growth, while its long-run numbers are driven by an assumption that government borrowing is terrible for growth (which is why CBO actually claims higher taxes boost economic output - see, for example, figure 3 of this CBO analysis). It is impossible to know whether the people at CBO actually believe their own work, or whether they are simply trying to please their political paymasters by producing results that (conveniently) match up with political preferences for more spending today and higher taxes tomorrow. You can draw your own conclusions, but keep in mind that CBO is now making the absurd claim that a giant new healthcare entitlement will reduce budget deficits.

But I digress. Let's now give the defense of Keynesian model. The folks at CBO and other Keynesian who publish estimates that inevitably turn out to be wrong (Mark Zandi comes to mind) will claim that they are right because they are predicting results compared to what otherwise would have happened. So when they claim that Obama's so-called stimulus created jobs, they are really saying that the economy would have lost even more jobs if the government didn't spend all that money. The problem with this approach is that there is no independent benchmark, but this is not why Keynesianism is wrong. Indeed, most of the economic profession relies on this kind of "counterfactual" analysis. Instead, the problem with Keynesianism is that it fails the empirical test. The Keynesians may be good at constructing models, but that doesn't mean much if the models don't match the real world. Here's what Kevin Hassett of the American Enterprise said in recent congressional testimony:

...most economists learned in graduate school that models like those relied upon most heavily by the CBO provide nonsensical results. The reason the original large scale Keynesian Macro forecasting models were discarded by most of the profession is that they make a simple logical error in assuming that individuals do not change their behavior based on the expectation of future policy. ...Professor Barro has been one of the primary contributors to the macroeconomic time series literature that has tried to estimate effects from observed economic data, rather than assume affects, as is done by the Keynesian models. ...Barro's analysis is based on econometric evidence, a reliance on experience. The CBO analysis is based almost exclusively on speculation within the context of Keynesian Macro models that were discredited decisively in the 1970s. ...Dating at least back to the seminal work of Nelson (1972), economists have known that the empirical time series approach significantly outperforms macroeconomic models in forecasting competitions. ...Ashley (1988) compares data based time series forecasts to those from the large macro forecasters and concludes not only that the time series approach is superior, but that the macro forecasts were so bad that, "most of these forecasts are so inaccurate that simple extrapolation of historical trends is superior for forecasts more than a couple of quarters ahead." ...Finally, one should note that this literature, combined with an earlier public finance literature, raises questions concerning the welfare gain associated with short-term increases in spending. ...Browning (1987) finds that the marginal cost ranges widely, between 10% and 300%. Thus, the welfare costs of paying the bill may be greater than the short-term boost to the economy from the most optimistic estimates. This literature would be consistent with Barro's analysis that suggests the stimulus makes us worse off in the long run.

Doubling Down on Big Government

This new video from the Center for Freedom and Prosperity explains how last year's so-called stimulus was a flop - and also reveals why politicians are pushing for another big-government spending bill.



Interestingly, since last year's stimulus was such a disaster, the redistributionists in Washington are calling their new proposal a "jobs bill." But as I say in the video, this is akin to putting perfume on a hog.

Don't Trust Economists

Sometimes a picture really does tell a thousand words. Here's a chart, based on data from the Philadelphia Fed, showing actual economic results compared to the predictions of professional economists. As you can see, my profession does a wretched job. Comparisons based on predictions from the IMF, OECD, CBO, and OMB doubtlessly would generate equally embarrassing results. This does not mean economists are idiots (insert obvious joke here), but it is an additional reason why Keynesianism is misguided. If economists are unable to predict what's going to happen with the economy in the near future, why should we expect anything positive when politicians tinker with short-run economic performance? That's especially the case when they pass so-called stimulus legislation that increases the burden of government spending.

h/t: James Montier, via Paul Kedrosky, via Andrew Sullivan

CBO, the Wizard of Oz, and the Keynesian Fairy Tale

The Obama Administration said that the so-called stimulus was necessary so that the unemployment rate would not rise above 8 percent. Indeed, the White House warned that the joblessness rate would climb to 9 percent if lawmakers did not approve the $787 billion package. Critics responded by explaining that making government bigger would divert resources from the productive sector of the economy and hurt growth. These skeptics also noted that nations using "Keynesian" policy, such as the United States in the 1930s and Japan in the 1990s, did not generate good results. And since the unemployment rate is now above 10 percent, it certainly seems like opponents were correct.

But now the supposedly non-partisan Congressional Budget Office has jumped to the defense of the White House, estimating that the spending bill actually generated beween 600,000 and 1.6 million jobs. How can that be, you may ask, when the number of jobs has fallen by more than 3 million? The CBO neatly sidesteps that real-world concern by moving the goalposts, using a slightly more sophisticated version of Obama's "jobs created or saved" alchemy. Their jobs-created estimate is compared to a make-believe baseline of how many jobs there would be "without the law."

CBO estimates that in the third quarter of calendar year 2009, an additional 600,000 to 1.6 million people were employed in the United States, and real (inflation-adjusted) gross domestic product (GDP) was 1.2 percent to 3.2 percent higher, than would have been the case in the absence of ARRA. ...CBO’s current estimates differ only slightly from those CBO prepared in March 2009. At that time, CBO projected that in the third quarter of 2009, U.S. employment would be higher by 600,000 to 1.5 million people with ARRA than it would be without the law, and real GDP would be 1.1 percent to 3.0 percent higher. CBO’s new estimates reflect small revisions to earlier projections of the timing and magnitude of changes to spending and revenues under ARRA. ...Economic output and employment in the spring and summer of 2009 were lower than CBO had projected at the beginning of the year. But in CBO’s judgment, that outcome reflects greater-than-projected weakness in the underlying economy rather than lower-than-expected effects of ARRA.

Needless to say, this means there is no objective benchmark. The unemployment rate could jump to 15 percent and total job losses could reach 10 million, but CBO would continue to say, for all intents and purposes, that the results from their Keynesian model are more important than any real-world numbers. This is the fiscal-policy version of the Wizard of Oz, and we're supposed to ignore reality just as Dorothy and friends were supposed to ignore the man behind the curtain.

To be fair, there is nothing inherently wrong with CBO's methodology. Economic analysis frequently requires people to make assumptions about how the world would behave with or without a certain policy. So the real question is whether Keynesian economics makes sense from a theoretical perspective, whether there is any suppporting evidence, and whether there are more compelling alternatives. Click the links and decide for yourself.

Even Obama’s Make-Believe Jobs Are Not Real

The White House recently began claiming that the “Recovery Act” had “created or saved” 640,000-plus jobs. This turns out to have been a political mistake, in part because even sympathetic reporters understand that the “jobs saved” measure allows for creative accounting. But the White House also erred by providing (supposed) details about the jobs that were created. This made it very easy for reporters and other curious people to do a bit of fact checking, which has generated a spate of stories showing that the White House’s numbers are wrong, even using make-believe methodology. The Washington Examiner has put together a very useful interactive map which links to many of the news reports debunking the Administration’s fraudulent numbers.

For a refresher coures in “stimulus” issues, here is the Center for Freedom and Prosperity’s three-part series on Keynesianism, stimulus, and growth.

Weekly Economics Lesson: Consumer Spending Is a Symptom of Prosperity, not the Cause.

One of the (many) frustrations of my job is dealing with the confusion about economic growth. It should go without saying that economic growth occurs when there is an inflation-adjusted increase in national income. Many policy makers (and journalists) presumably understand this elementary observation. Yet those same people usually attach great importance to monthly data on consumer spending. There is nothing wrong with that data, to be sure, but there is something wrong with how it is analyzed. Many people assume that consumer spending drives growth because it is roughly two thirds of the economy. But this puts the cart before the horse. Higher levels of consumer spending do not cause prosperity. Instead, more consumer spending is best understood as a symptom of prosperity.

Consider an example: Would it be a positive sign if national income fell by 1 percent (and assume that this translated into a 1 percent fall in disposable income), but people increased consumer spending by 2 percent by borrowing lots of money and utilizing their credit cards? Retails stores might be happy, but clearly this pattern would not be sustainable.

This is why "Keynesian" policies are misguided. The goal of Keynesianism is to have the government borrow money and then to distribute that money to consumers. Yes, that may bolster consumer spending, but only at the expense of investment spending. After all, the government had to borrow the money out of private credit markets.

"Cash for Clunkers" Symbolizes Government Stupidity

A fallacy (one of many) of Keynesian economics is that it incorrectly assumes that consumption is the cause of economic growth rather than the result of economic growth. This leads advocates of this misguided theory to adopt policies designed to get people to spend more - even though economic growth (by definition) is the result of people earning more income. This absurd logical mistake is evident in the cash-for-clunkers debacle, as I explain to Foxnews.com:

...critics have a different view. "This is not good for economic growth," said Dan Mitchell, a senior fellow in economics at the Cato Institute. "You're simply getting people to use existing income to spend on cars. Getting people to spend more of their money on cars mean they will have less money to spend on other things." Economic growth, Mitchell argued, is not getting people to spend more money on products, it's getting them to have more income. Mitchell also believes the program is counterproductive for the auto industry down the road because the acceleration in car purchases will precede a "big downturn in the future." "Giving someone a shot of heroin is not good for their long term health," he told FOXNews.com. The program, Mitchell added, shows that the government is "incompetent."

The Wall Street Journal has the same perspective, noting that the policy is not a success - unless one defines success as getting people to buy things with other people's money:

What the clunker policy really proves is that Americans aren’t stupid and will let some other taxpayer buy them a free lunch if given the chance. The buying spree is good for the car companies, if only for the short term and for certain car models. It’s good, too, for folks who’ve been sitting on an older car or truck but weren’t sure they had the cash to trade it in for something new. Now they get a taxpayer subsidy of up to $4,500, which on some models can be 25% of the purchase price. It’s hardly surprising that Peter is willing to use a donation from his neighbor Paul, midwifed by Uncle Sugar, to class up his driveway. On the other hand, this is crackpot economics. The subsidy won’t add to net national wealth, since it merely transfers money to one taxpayer’s pocket from someone else’s, and merely pays that taxpayer to destroy a perfectly serviceable asset in return for something he might have bought anyway. By this logic, everyone should burn the sofa and dining room set and refurnish the homestead every couple of years.

Last but not least, the CEO of Edmunds, the company that publishes leading car-buying guides, has a column in the Wall Street Journal explaining that even auto companies may come to regret this policy since the net effect seems to be that consumers either postponed or accelerated purchases that would have occurred anyway:

...it’s not clear that cash for clunkers actually increased sales. Edmunds.com noted recently that over 100,000 buyers put their purchases on hold waiting for the program to launch. Once consumers could start cashing in on July 24, showrooms were flooded and government servers were overwhelmed as the backlog of buyers finalized their purchases. Secondly, on July 27, Edmunds.com published an analysis showing that in any given month 60,000 to 70,000 “clunker-like” deals happen with no government program in place. The 200,000-plus deals the government was originally prepared to fund through the program’s Nov. 1 end date were about the “natural” clunker trade-in rate.