Keynesian Economics, Government, and Budget Deficits
Keynesian Economics, Government, and Budget Deficits
Whatever your beliefs, I recommend that you read Genesis 41. It contains important lessons for modern-day economics.
Genesis 41 is the story of Joseph interpreting Pharaoh’s dreams about a famine which is to come. Joseph’s advice to Pharaoh, depicted in the narrative as being extremely wise, was to save the people of Egypt through the use of Keynesian economics. Of course, that terminology isn’t found in the story – it would be thousands of years before Keynes would come along. But the actions advised by Joseph and Keynesian economics use the same principles. Joseph advised Pharaoh to take up a tax during the good years as a protection against the consequences of the inevitable bad years to come. You might not recognize that this is an ancient description of modern-day Keynesian economics. Rather than being a modern liberal scheme, Keynesian economic concepts can be traced all the way back to the Torah – all the way back to the very first book of the Bible.
Keynesian economics is widely misunderstood. Arguments against its use tend to be straw man arguments against a misunderstood concept of Keynesian economics. This misunderstanding has been compounded by additions and alterations to economic theory as well as the creation of new branches of economic schools of thought by those who call themselves Keynesians. When I use the term “Keynesian economics”, I am specifically referencing the concepts taught by John Maynard Keynes, and not the concepts added over the years by neo-Keynesians and others.
John Maynard Keynes’ writing is somewhat difficult to read, especially for those who are untrained at reading text regarding economics concepts and theory. According to classical economic theory, an economic collapse as deep and as lengthy as the Great Depression could not possibly occur – yet it did occur. According to classical theory, the economy would very quickly correct for such a collapse – yet that correction did not occur. Perhaps the correction would have come eventually. But during the depths of the Great Depression, it was clear that we couldn’t afford to wait for “eventually” to get here. Along came Keynes, with a new theory to explain…
- why the Great Depression occurred
- what the government could do to fix it
- how to deal with economic downturns in the future
- how to prevent future catastrophic economic events
Since this was a new theory to replace a prevailing-yet-now-debunked theory, Keynes needed to include a lot of details in his writing; details which served to put an understanding of his writing beyond the reach of the general population.
Perhaps these details hide the basic principles behind Keynesian economics and help lead to confusion. The basic points are:
- Economic collapses beyond an acceptable level are possible
- The government can make these collapses less catastrophic, less frequent, and shorter in length through fiscal policies, which are policies involving taxing and government spending
- This involves using gains earned during good economic times to pay for the bad economic times
These basic points are often misunderstood because they can hide behind the details and the rhetoric.
Classical economic theory had been debunked by the reality of the Great Depression. Those who initially opposed Keynesian methods were, for the most part, not classical economists but Monetarists. Monetarists believed that fiscal policies were riskier and perhaps less effective than monetary policies involving government intervention in interest rates and the money supply. Monetarists tended to be conservatives who would avoid the use of fiscal policies as tools to influence the economy, and instead use a consistent monetary policy which should only be changed in the direst of circumstances. The leader of the Monetarist movement was the conservative economist Milton Friedman.
Today’s liberal economic policies have generally descended from Keynes while today’s conservative economic policies have generally descended from Friedman. These are only generalizations, however, and are based more on the historic timeline of policy changes than on adherence to original theories. Conservative rhetoric today often seems to be more in line with the debunked classical theories than with the original Monetarists.
There are liberal advocates who claim that Keynesian economics has never actually been attempted in the United States, at least not to the extent that Keynes advocated. The New Deal is generally thought to be a massive Keynesian departure from anything previously attempted. Keynesian economics provided a justification for such a departure. Yet Keynes and Roosevelt did not see eye to eye on economic policy. To Keynes, the New Deal did not provide enough of a jolt to the economy. It wasn’t big enough, and its stimulus policies were abandoned long before full recovery.
Conservative rhetoric includes a number of misconceptions regarding Keynesian economics. I want to mention a few of these misconceptions:
- Contrary to the rhetoric, Keynesian economics is not socialism, and it is not “big government”. It is simply using the gains from good economic times in order to avoid the worst consequences of bad economic times through fiscal policy. Keynes had been, and remained, a free-market advocate.
- Keynesian economics cannot be blamed for long-term growth in the national debt. On the contrary, long term deficits which increase the debt are created through deficit spending during good economic times. Budget deficits during good economic times run counter to Keynes’ philosophy. Keynesian deficits are recession-fighting tools, not a normal way of economic life. John Maynard Keynes was very upset with Roosevelt for massive government debts incurred for war efforts. To Keynes’ way of thinking, if there is not enough of a surplus built up to pay for hard economic times, then short term deficits are preferable to widespread pain and suffering – we will just cover these deficits when economic times improve. The point is to hasten the day when the economy improves, and mitigate the consequences in the meantime. Eliminating pain and suffering by spending accumulated surpluses is preferable to deficit spending, but short term deficits are preferable to allowing widespread pain and suffering.
You can think of government surpluses as a rainy day fund. The Great Recession which officially began in December of 2007 and the deficits which resulted from it were made much worse because a budget surplus had been squandered on inappropriate tax cuts and unpaid-for war efforts. If the surplus had still existed in 2007, the steps necessary to end the recession would have involved less public deficit spending.
- Contrary to the rhetoric, Keynesian economic policies are Constitutional and are consistent with the intent of the Founding Fathers, even if the same Founding Fathers could not possibly anticipate such changes to prevailing academic thought regarding economics.
Prior to Keynes, the idea of using government policy to influence economic outcomes was alien to most economists. After Keynes, this same idea became encoded in federal law. The Employment Act of 1946 requires the government to make policy for the purpose of generating full employment while maintaining price stability. This law has no real teeth: It doesn’t define how the government is supposed to do this; it doesn’t specify which policies to use; it doesn’t provide for direction when the twin goals of employment and price stability clash; and it doesn’t specify measures of success. But it is law, and both fiscal and monetary policies have been implemented for the same purposes that the law was created for. This law implies that activist economic policies should be used not only after the economy has gone into recession, but also to prevent recessions in the first place. Activism to prevent economic instability caused by price fluctuations is also implied.
What is the government’s track record for meeting the terms of the Employment Act of 1946? Has the government succeeded in generating employment while maintaining price stability? Let’s compare the record before interventionist policies with the record since these policies have been used. The data clearly shows that overall, economic stability has increased – not decreased – with these policies. Perhaps we can all disagree with specific policies at specific points in time, but I think the overall track record is quite impressive. How much of the increase in stability that can be credited to…
- automatic stabilizers and other recession-related Keynesian policies
- activist monetary policies through the Federal Reserve
- elimination of a gold standard
- other factors
are questions that are open to debate. But the track record is very clear. The United States’ economy has become much more stable with activist policies. I have some tables showing relevant economic data for the years that the data is available.
U.S. GDP 1929-2013
U.S. Federal Revenue, Spending, and Deficits 1929-2013
U.S. Annual Employment Data 1943-2013
U.S. Miscellaneous Economic Data 1929-2013 (Inflation; minimum wage; top marginal individual and corporate tax rates; percent of employed belonging to labor unions)
The data in these tables indicate an increase in economic stability. In addition to the data tables, here are some key graphs.
Recessions involve widespread unemployment. The state of the economy coming out of a recession is always at a lower point than it was going in. Recessions have become less frequent, shorter in length, and less severe than they were prior to the Employment Act of 1946.
You might notice from this last graph that the Great Recession beginning in December of 2007 is clearly out of line with all other recessions since the Employment Act of 1946 in terms of severity. Much has been written about the causes and consequences of the Great Recession, but you might want to keep this graph in mind whenever a discussion turns to reasons it has taken much longer to reach full recovery from this recession than from other recent recessions. You might also notice that the Great Recession is very much in line with economic downturns which occurred prior to 1946. The economic history of the United States involves several economic collapses prior to 1946, many of which are referred to in history books as depressions rather than recessions.
This graph illustrates the record of monthly private sector job gains and losses beginning with 2007, the year that the Great Recession began. The official end of this recession was June 2009. Red bars indicate months with net job losses; blue bars indicate months with net job gains. The longer the red bars, the more jobs were lost during that month. Prior to the stimulus package of 2009, the U.S. economy was experiencing widespread job losses, and the number of jobs being lost was increasing month after month. The economy was in a free-fall. Almost immediately following the stimulus package, the economy showed improvement in terms of private sector jobs. The number of monthly job losses decreased month after month, until they turned into monthly job gains. Once they reached the point where the bars in the above graph are shown in blue, the economy remained in the blue. This means that we have experienced monthly job gains since the effects of the stimulus ran their course. This is not full recovery, however. The blue bars would need to be longer in order to grow the economy and eliminate long-term unemployment. The economy clearly changed course for the better following the stimulus, but Congress has refused to provide additional stimulus in order to complete the recovery in terms of jobs.
Overall, prices have become more stable. For the most part, inflation has been high enough to avoid the dire consequences of deflation. Inflation has largely stayed in the range considered by most economists as being consistent with economic growth. Despite numerous predictions of doom over the years, inflation has never approached anything close to hyperinflation. Except for events related to the Arab oil embargo of the1970s, inflation has rarely topped 5% per year. The last time we had an inflation rate above 5% for an entire year was 1990, at 5.4%. The last year of double-digit inflation was 1981, at 10.3%.
The historical data does not support a claim that such a trade-off exists under normal circumstances.
Below is a scatter chart plotting all points of inflation and unemployment since 1943, which is the first year for which records are currently available. No trade-off between inflation and unemployment is indicated here, either.
The story of Joseph and Pharaoh was set in ancient times involving an ancient economic system. Modern-day economic methods and tools are much different. The tax imposed by Pharaoh actually involved the government confiscating land from the private sector, in order for the government to claim ownership of a 20% tax on crops. Today, our economy is much more complex, and tax involves payment of money rather than land and crops.
Keynesian-type policies allow for short term debt to be part of the process, if necessary. But government debt can certainly exist outside of any anti-recession policy. Long term debt always does. It does not follow logically, or economically, that the use of government debt as part of fiscal policy for fighting recessions means that all government debt is caused by Keynesian economic policies.
Ignore the rhetoric, and check the record. Short term government debt created in fighting the consequences of recessions is sometimes necessary for the stability of the overall economy, as well as the well-being of individual citizens. We have numerous automatic stabilizers in place which serve these purposes. A balanced budget amendment, even if it is well-intentioned, would undermine the entire economy. It takes an understanding of the difference between deficits created for economic stabilization (short term, or cyclical, deficits) and deficits created for other purposes such as war or to provide tax breaks (long term, or structural, deficits).
The former are Keynesian deficits; the latter are not.
A version of this essay is included as a chapter in the book Common Misconceptions of Economic Policy by Jerry Wyant. You can purchase this book in paperback form from Amazon and other online book distributors. The list price is $12.99 (only $9.99 using discount code TA9GTK7E when ordering, depending on the distribution channel). Or if you prefer, you can download a digital version on your device (Kindle, Nook, etc.) for $4.99.
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