Identity confusion is muddying the waters of public discussion about what economic policies our nation should follow in the wake of the worst financial system crisis in 80 years and the worst recession in 30.
If you are a Republican, does that mean you automatically oppose the ideas of British economist John Maynard Keynes, who advocated government action to buffer recessions and inflation? If you are a Democrat, should you automatically support Keynes? And if you are an independent, how can you distill any consensus from the widely disparate prescriptions flung out by economists of varying political persuasions?
It is paradoxical. Governments of virtually all important countries in the world including the United States, China, Japan and most of Europe, are implementing Keynesian-based fiscal and monetary stimulus packages to buffer the ongoing recession. But many people, especially in the United States, increasingly express opposition to such stimulus and call instead for deficit reduction, exactly the wrong thing to do at this point in time from Keynes’ point of view.
Keynes was a British economist who lived from 1883 to 1946. In the 1930s, in response to the global Great Depression, he broke with his early belief in a limited role for government and argued that there are situations where government not only could, but should, intervene to manage overall economic activity.
Government could not make an economy grow faster over the long run. But it could soften the magnitude of swings in the business cycle, the irregular but well-established swings in output, employment and inflation, Keynes said. Monetary policy — changing the money supply and thus changing interest rates was one tool to stimulate a recessionary economy or to damp inflation. Fiscal policy, altering levels of taxes and government spending, was another.
In case of inflation, a nation’s central bank should restrict money growth, he said. Doing so would push up interest rates. The legislative and executive branches should increase taxes and cut spending.
In case of recession, the central bank should increase money growth and push down interest rates. Taxes should be cut and spending increased.
Combating a recession might require budget deficits, but surpluses run up during booms would offset these, Keynes said. He did not call for long-term deficit spending or increases in national debt levels.
By the 1960s, a large majority of all economists were Keynesians, and virtually all introductory economics textbooks were based on Keynesian assumptions. But there were dissenters. Monetarists like Milton Friedman still advocated a minimal role for government, as did their intellectual heirs, the rational expectationists. So did the supply siders, a small group that got little respect within academia but had great influence within the Reagan wing of the Republican Party.
The 1970s era of “stagflation,” simultaneous high unemployment and high inflation caused by the application — or misapplication -— of Keynesian policies, eroded the overwhelming predominance of the Keynesian thinking within the discipline of economics.
Keynesians had to retrench. They had to revise their theories to meet the criticisms of the rational expectationists, who argued that rational people reacted to government manipulation of the economy in ways that nullified whatever the government policies were intended to accomplish. And most Keynesians became leery of attempting to micromanage the economy, trying to offset the most minor shifts in key indicators.
So Keynes’ ideas do not have the hegemony that they did in the 1960s. But they retain powerful influence among many academic economists and those in government and on Wall Street.
Yes, economists who are Democrats are likely to be Keynesians. And members of groups opposing Keynes are more likely to be Republicans. But this does not mean there is a neat split, for many Republican economists are still Keynesians. Ben Bernanke is one. Greg Mankiw, head of President George W. Bush’s Council of Economic advisors is another, as is John Taylor, who held a No. 2 position at the Treasury in the Bush administration and advised John McCain. So is Ken Rogoff, former chief economist at the IMF and a McCain supporter. The list goes on and on.
Moreover, if you ask the question, “Should the government use fiscal and monetary policies to counteract a historically severe recession, or should it stand aside?” many economists who are skeptical about Keynesian policies in more normal times would say yes. Martin Feldstein, head of Ronald Reagan’s CEA and a long-time advocate of low tax rates, came out in support of a even larger stimulus package than that passed by Congress early this year, even though he disagreed with many specific aspects of that bill.
When the bill was debated, some 400 economists signed a newspaper ad opposing it. The list included many distinguished economists, including a few Nobel winners. But most were theoreticians or college teachers. Few had ever held a policy position of any consequence. And the list of prominent Republican economists who chose to not sign the petition would be equally as long.
Economists are divided on what policies are best right now. Democrats do tend to favor government action. Republicans are divided. Overall, there probably is a strong majority among economists in favor of some level of stimulus. But it is not a neat split where party divisions align neatly with those in the discipline of economics.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.