Friday, June 03, 2011

How's That Keynesian Thing Working Out For You?

Had you listened to the Austrian economic model today's economic news of pathetic job growth and increased unemployment would have come as no shock. However, I am aware there are still some of you that believe in Keynesianism and are dumbstruck as to why the economy isn't booming and so permit me a lesson in economics.

You see, despite $2 trillion in "stimulus spending" and lord knows how much more in deficit spending, according to the Keynesian model this spending should have rippled through the economy and via a "multiplier effect" resulted in a multiple of the original stimulus amount in economic growth. This would have shifted the aggregate demand curve to the right resulting in full production and employment. Confetti would fall, Peggy Joseph wouldn't have to pay for her mortgage, the masses would cheer and Obama's Magical Flying Unicorns would fly in formation over the cheering masses (they're kind of like the Blue Angels, but not as cool).

Now, just assuming a multiple of 5 (meaning the MPS is .2, which it's not) that means a minimum of $10 trillion in additional economic production should have occurred just on the stimulus spending alone. Divide that by Obama's 3 years in office and roughly $3.3 trillion in extra economic growth over our base of $13.5 trillion should have resulted in a GDP of roughly $17 trillion. We're still sitting at $14 trillion.

So what happened?

Well Keynesian Kiddos, your dated model might have a little flaw. The MPC or alternatively the MPS.

You see, when you are mortgaging the future of the country to the point credit rating agencies are downgrading you people have a tendency not to want to spend or invest a lot in the country. Also, when you basically villainize profits, production and capitalism, businesses and banks don't want to invest. And when you just go and blow annually $1.4 trillion more than what you take in (all while making the taxpayer responsible for this profligate spending) people in general just lose faith in the country. So instead of the "happy go lucky spending spree" your model is based upon you see people tighten their wallets and spend less. Ergo our MPS goes up and your multiplier effect goes down;

In short, you failed to account for the psychological effect of bankrupting a country and what kind of effect that might have on people's spending as well as business investment.

Of course this "magical multiplier" effect of Keynesianism was flawed from the beginning. Not because there isn't a multiplier effect, but because it has nothing to do what what really matters; genuine economic production.

Spend all the government money on "community centers," "art programs," and "stimulus programs" you want, it's not what the people wanted. And claim all you want that "additional spending" is now rippling through the economy, the fact is the government wasted that "first round" of spending on something nobody wanted. That money, had it remained in taxpayer's hands would still be rippling through the economy, but through private hands (either through personal consumption or lending via banks) and therefore producing things people wanted. Not "$50,000 drinking fountains."

Perhaps a simpler way to explain it is to aliken Keynesianism to the "why can't we just print off more money" question. You don't have to be able to answer the question to know deep down in side you intuitively know that would not solve the problem.

So perhaps in your next economics class in college you can ask your economics "professor" a variant of that question with the presumption Keynesianism works.

"If the government can spend its way out of a recession, why can't the government just spend enough to spur enough economic growth so that we're all trillionaires?"

I myself would love to hear the answer to that question.


Ryan Fuller said...

"If the government can spend its way out of a recession, why can't the government just spend enough to spur enough economic growth so that we're all trillionaires?"

They'd probably say that the economy can't be stimulated beyond potential output, and it's currently performing below that level because we didn't throw enough trillions of dollars at it fast enough, so the correct course of actions would be to throw even more trillions of dollars at it even faster with even less warning and it will definitely work this time.

Anonymous said...

There seems to be a strong case that the the stimulus package actually decreased or held back private sector employment. Most of the money went to expand public sector employment at local, State, and federal levels. Washington DC has been the growth area of the USA.
Most government officials, have no idea that taxing the private sector into a government spending binge is a bad idea.
The spending party is coming to an end. And the debt hangover is waiting for the wake up call. Greece may end up looking like the pregame show, to an even worse debt crisis in the USA.

Anonymous said...

It is amazing how resilient and strong your great country is. The Obama administration, and its Congressional enablers, would have destroyed any other country, would have reduced it to a Zimbabwe.

And yet you have even achieved a little growth. Truly amazing.

But the Obama administration should not have happened.

Rick Caird said...

The politicians love Keynesian economics because it allows them to spend money they don't have and call it "stimulus". I do remember Pelosi licking her chops as she said "stimulus". She thought it was a free lunch.

But economists like Krugman, DeLong, and Goolsby should be able to recognize that Keynesian economics does not work. It merely leaves an ever increasing debt burden. For some reason, though, they do not see this. "When your only tool is a hammer, every problem looks like a nail".

Anonymous said...

This was explained to me once like it was hard drugs:

You take one little hit, you feel great. ( A little deficit spending gets the economy humming along)

But the next hit has to be bigger to get the same high.

and so on..

Until basically you take a hit so BIG that A. Your heart blows up B. You didn't even get high.

We've been taking loans ( drugs) out for decades and now we're taking huge hits of it and the effect is, um, disappointing.

The eternal problem with drugs ( medicinal and recreational (have a cold beer, eh?)), in moderation they are great, but you gotta watch the dosage and purity.

Rehab is going to really stink.

MichaelV said...

"If the government can spend its way out of a recession, why can't the government just spend enough to spur enough economic growth so that we're all trillionaires?"

The answer is that it absolutely CAN do that!

The trouble is that it will cause so much inflation, that when you become that trillionaire, it won't buy you a cup of coffee because that will cost $10 trillion.

affirmative action Obama... said...

Careful what you wish for Cap'n, you certainly all could be trillionaires in the near future, just like the folk in Zimbabwe.

Ask them how they are liking it so far.

Ofay Cat said...

So China is the happiest country in the world?

grerp said...

But, but:

Money is the solution. Throw more money at the problem, even if you have to print it or hock it from your kids and their kids.

Anonymous said...

I agree with the statements. But in defense of Keynesian economics (I am not a fan), he also made it very clear, governments also have to pay off their debts. This has never happened in any of the post War Western democracies. All these central governments just keep adding debt onto more debt. During growth periods according to Keynes, governments were supposed to pay off their debt obligations. Instead they increase government services/spending, during the boom years.

This would be like an individual using a credit card, and never paying the bill.
Keynes never ever supported debt loads that run on forever.

bruce said...

part of the Keynesian thing is when and were it originally happened. In Britain at that time there was a massive underinvestment in modern plant and infrastructure. Not the same thing a rewarding leftist ideological spending on political projects

Dalrock said...

Excellent post. I had the chance to study graduate level Macroeconomics under my favorite professor just before graduating with my bachelors in Economics (20 years ago). We studied Robert Barro's model which fit closely with your analysis here. It was the first time Macroeconomics made any real sense to me, and I was in the top of my class in both Micro and Macro Economics (top 1% nationally per the Princeton test).

My favorite Keynes quote sums it up pretty well: "The long run is a misleading guide to current affairs. In the long run we are all dead." Sure, he's dead, but the rest of us need an economic model which actually works.