Friday, March 16, 2012

John Maynard Keynes Was Right (and not for the reason you think)

For more than eight decades, famed economist John Maynard Keynes has been the subject of much discussion and debate.

Many observers attribute his scholarly positions on monetary policy with ending the Great Depression, while others have negatively viewed him as a champion of big government and unsustainable deficit spending. The latter has made him a scourge to conservatives ever since.

However, what is often overlooked is that Keynes advocated both tax cuts and budget surpluses. Deficits, he believed, were to be begrudgingly accepted as a necessary evil only in some circumstances.

Like all economists, Keynes theories on economics boiled down to the basic laws of supply and demand.

However, unlike others before him, Keynes believed that demand drives supply. In Keynes view, insufficient demand leads to unsold goods, which leads to layoffs. Ultimately, insufficient demand leads to a downward spiral of unemployment, poverty and even depression.

Keynes' remedy in these instances was to artificially stimulate demand by increasing government spending or cutting taxes, which ultimately encourages the public to increase its spending instead. The idea was to cause either the government or the public to increase spending to stimulate the economy.

These goals were to be achieved through fiscal policy; spending measures or tax cuts. Yes, Keynes actually advocated cutting taxes.

Keynes favored deficit spending only to combat depressions, not to fight low levels of unemployment. He also advocated creating surplus budgets to eliminate government debt in times of prosperity.

Yet, that approach has been largely ignored for decades. The overall debt has increased under every president since the 1940s, regardless of which party has controlled Congress. Even during times of extraordinary economic expansion, debt has continued to pile up.

The primary concern about large government debt is that it can fuel inflation.

Notably, Keynes believed that inflation could be cured with the help of budget surpluses and/or restrictive monetary policy. If demand (or spending) are reduced, then prices start falling.

Though Keynes argued for budget deficits to stimulate demand, he also advocated for subsequent budget surpluses to eradicate debt. That part of the equation seems to have been forgotten by many.

The public debt has increased by over $500 billion each year since fiscal year (FY) 2003, with increases of $1 trillion in each FY since 2008. The fiscal year begins on October 1 and ends on September 30 the following year.

The national debt is now in excess of $15.5 trillion and there is no end to the deficits in sight. Interest payments are consuming an ever-larger portion of the budget each year as the debt grows. And, though currently at historically low levels, interest rates are poised to increase — perhaps significantly — in coming years. That could make debt management impossible.

Budget surpluses now seem like a pipe dream. They are a distant memory from the 1990s. Keynes would surely be disappointed, if not appalled.

And though consumer demand remains constrained by a variety of factors (high unemployment, stagnant wages, the bursting of the housing bubble, etc.), with such an enormous debt the government is hamstrung to engage in further deficit spending to stimulate demand.

The nation's infrastructure is crumbling and received a cumulative grade of D from the American Society of Civil Engineers. And the nation desperately needs to invest in scientific research to remain competitive in the 21st Century.

Yet, in both instances, the government is handcuffed by its enormous debt. With trillion dollar deficits adding to the mammoth debt each year, how can anyone reasonably argue for piling on yet more debt, no matter how worthy the cause?

When Vice President Dick Cheney famously stated, "Reagan proved that deficits don't matter," he was wrong. Very wrong. They do matter. A lot.

Keynes knew this all along.


  1. Anonymous12:30 PM

    Keynes was a crackpot, pure and simple. Once a government intervenes in the economy, it will screw it up. For example, how much deficit spending is enough? How will government surpluses be gained, if not by over-taxation? Obviously, boom-and-bust cycles will be a permanent fixture of his absurd theory.

  2. Anonymous2:45 PM

    It funny that those that believe Hayek economics is right, forget that the Great Depression occured while goverment non-intervention was the normal fiscal policy.
    Don't worry is no one is driving the train, it will evenutally stop on its own.

  3. It's also funny when some people insist that government spending didn't end the Great Depression, but that WWII did.

    WWII was the greatest example of government spending in modern times. It was absolutely massive deficit spending.

    Six of one, a half dozen of the other.

  4. New technologies and new methods ended the Great Depression. Like Adam Smith said, The only way you increase your standard of living over time is through increases in productivity due to two things that are often interrelated: new technologies and new methods. It wasn't the spending or we would have imploded over war debt in a few short years. It was the efficiency learned to build the massive war machine (mainly companies figured out). It was supply creating demand through new inventions and new processes (building many new houses more cheaply and efficiently, cars, refrigerators, etc.) It was classical economics, supply creating demand, not Keynes's extremely foolish theory that demand creates its own supply. Keynes will be the death of us.

    1. If supply created demand, there would never be the problem of inventories piling up in warehouses and on store shelves. If there's no demand, there's no reason to create supply.