Nobel Prize-winning economist Paul Krugman recently claimed that John Maynard Keynes -- or the general idea of Keynesianism -- is winning the battle of opinion in the public sphere. George Mason University economist and blogger Tyler Cowen responded, playing devil’s advocate, and listed a bunch of points that he thinks indicate that Keynesian ideas (liquidity traps are important, austerity during recessions is destructive, fiscal stimulus is useful) might be losing the substantive battle.
Econ blog arguments are fun, so I’ll play devil’s advocate squared -- angel’s advocate? -- and go through some of Cowen’s points.
Here is Cowen:
Keynesians predicted disaster following the American fiscal sequester, and the pace of the recovery accelerated.
This is intriguing, especially in light of the fact that everyone blames a 3 percent sales-tax hike in April for crashing the Japanese economy. If that small tax increase sent the Japanese economy into a tailspin, why didn’t the across-the-board spending cuts of the sequester inflict similar damage on the U.S. economy? Why the differential vulnerability? This does make me doubt the standard Keynesian story.
The UK saw a rapid recovery, and the BOE kept nominal GDP growing at a good pace, even in the presence of a so-called “liquidity trap.” This is not mainly due to the UK having “stopped tightening,” nor did the Continental economies which let up on austerity see similar recoveries. Nor had the Keynesians predicted that letting up on tightening would bring such a strong recovery, (Larry) Summers for instance had predicted exactly the opposite.
Um, no. In what alternate universe did the U.K. see a rapid recovery? By many measures, this recession was worse than the Great Depression for the U.K. So this point doesn’t work.
Rate of change recoveries in the Baltics — which really did try a kind of radical austerity — have been stronger and more rapid than Keynesians were predicting, even if absolute levels remain less than ideal.
Levels and rates of change are not independent. See Milton Friedman’s concept of “string-plucking,” in which sharp recessions are followed by strong recoveries. Having your economy crater often allows you to grow fast in terms of growth rates to catch back up, but it’s still not a good thing.
Ireland finally is seeing a rapid recovery, albeit one with highly uneven distributional consequences and possibly another real estate bubble. The “get the pain over with” approach is looking better right now than it did say two years ago.
This doesn't sound like a stellar recovery for Ireland, so at the very least there is little that Ireland can tell us about Keynesianism.
Japan is in a (supposed) liquidity trap, but negative real shocks have not in fact helped their economy, contra to the predictions of that model (start with here and here). Nor does anyone think that the bad weather in the first quarter of U.S. 2014 was good for us, although a basic liquidity trap model implies it will boost inflation (beneficially) because the supply restrictions lead to price hikes which tax currency holdings and thus boost aggregate demand. Come on, people, that is weak.
This is a good point (and I also like the use of the rhetorical device “Come on people, that is weak”). The main academic models that support the Keynesian story have tons of holes in them, as all academic macroeconomic models do. They make lots of counterfactual (i.e., wrong) predictions. People who like these models will say that the models explained the one or two phenomena they were meant to explain, and who cares about all the other stuff they got wrong. People who don’t like the models will point to all the stuff they got wrong. This is basically how academic macro works.
A lot of the cited predictions of the Keynesian or liquidity trap model are in fact simple predictions of efficient markets theory (such as on interest rates), predictions of market monetarism or credit-based macro theories (low inflation), or regularities that have held for decades (budget deficits not raising real interest rates). It’s just not that convincing to keep on claiming these predictions as victories for Keynesianism and in fact I (among many others) predicted them all too. I never thought I was much of a sage for getting those variables right.
This, as far as I can tell, is correct. However silly academic macro debates are, casual macro debates in the media are five times more confounding. The theories and the predictions are all too vague.
And, finally, Cowen:
Where Keynesian views have looked very good is that government spending cuts do — these days — bring steeper and rougher gdp tumbles than was the case in the 1990s. That is very important, but a) it is increasingly obvious that there is catch-up for countries with OK institutions, and b) correctly or not, the world really hasn’t been convinced there is major upside to expanding fiscal policy.
This is a vote in favorof Keynesianism. So I’m not sure why it’s on the list!
Anyway, Cowen makes a number of other points, but they are all either neutral on Keynesianism, or deal, as Krugman’s post did, with the public perception of the debate rather than the question of whether Keynes is right.
So my conclusion from going through Cowen’s points is this: Our casual evidence indicates that government spending boosts gross domestic product during recessions. But we don’t really have a satisfying, formal, modern, rigorous, academic macroeconomic model that explains this fact.
That conclusion fits well with papers I’ve been seeing lately. But that, dear readers, is a story for another day. In the meantime, let’s avoid giving old Keynes the boot.
Image credit: International Monetary Fund