The Keynesians are dead … long live the Keynesians

Back in the years between 2008 and 2010 Amer­i­cans were con­stantly bom­barded by the “S” word, that word being “stim­u­lus.” Accord­ing to the macro­eco­nomic the­ory espoused by John May­nard Keyes, dur­ing a reces­sion pol­i­cy­mak­ers can stim­u­late aggre­gate demand by increas­ing gov­ern­ment expen­di­tures and/or cut­ting taxes. One or both com­po­nents of this fis­cal pol­icy fix for our nation’s eco­nomic ills were fol­lowed by George W. Bush and Barack Obama, with both pres­i­dents sug­gest­ing that mil­lions of jobs would fol­low, along with the eco­nomic pros­per­ity that every­one des­per­ately wanted.

Not only did the country’s fis­cal pol­icy man­agers want to fol­low the Key­ne­sian pre­scrip­tions for cur­ing our eco­nomic ills, so did the Fed­eral Reserve via mon­e­tary pol­icy actions. While gen­er­ally thought to be less effec­tive than fis­cal pol­icy (accord­ing to Key­ne­sians), the low-interest rate poli­cies of the Fed were meant to stim­u­late the econ­omy by mak­ing the cost of bor­row­ing less for both con­sumers and busi­nesses. Of course, we now know the fore­casts for those mil­lions and mil­lions of jobs that were sup­posed to be cre­ated were off the mark by, well, mil­lions and millions.

Apol­o­gists for the Key­ne­sian per­spec­tive now say that they under­es­ti­mated how bad the econ­omy was, but that seems to be lit­tle more than a ratio­nal­iza­tion for a poorly per­form­ing set of mon­e­tary and fis­cal pol­icy tools. Even when the Key­ne­sians thought they had finally seen the light at the end of the pol­icy tun­nel, the light quickly faded and a sub-par eco­nomic per­for­mance returned. Do you remem­ber “recov­ery sum­mer” of 2010? How about 2011? About as quickly as the recov­ery sum­mers appeared, they disappeared.

So down­trod­den were the pro­po­nents of Key­ne­sian eco­nom­ics that for the past cou­ple of years, no politi­cians dared utter the “S” word. At last, it seemed, the sim­plis­tic notions of Key­ne­sian eco­nom­ics were finally dead.

But then again, not.

In the past few weeks, despite this most recent evi­dence that Key­ne­sian theory-inspired fis­cal and mon­e­tary pol­icy impacts seemed to bear lit­tle resem­blance to real­ity, some pol­i­cy­mak­ers are res­ur­rect­ing these ques­tion­able pol­icy guide­lines, both in the U.S. and abroad.

Per­haps the most extreme case of Keynesian-amnesia is occur­ring in Japan where upcom­ing elec­tions will select that country’s next prime min­is­ter. For­mer PM Shinzo Abe is propos­ing a huge fis­cal stim­u­lus — appar­ently he does not fear the S-word — with gov­ern­ment spend­ing a huge $2.5 tril­lion on var­i­ous pub­lic works projects. In addi­tion to this fis­cal jolt to the recession-bound Japan­ese econ­omy, Mr. Abe wants to reduce the Bank of Japan’s inde­pen­dence (their ver­sion of our Fed­eral Reserve) and advo­cates an almost mind-boggling mon­e­tary stim­u­lus that could well pro­duce neg­a­tive inter­est rates as a means of break­ing the back of reces­sion and defla­tion. No doubt about it, this guy’s a turbo-charged Key­ne­sian who might well be tak­ing one of the most heavily-indebted nations in the world and turn­ing it into another Greece-like econ­omy within the inter­na­tional com­mu­nity. Of course, the poli­cies could work, but given the evi­dence of the past few years, does this seem like a good bet?

Back here at home in the U.S. the fis­cal cliff that is fast approach­ing seems to give fis­cal pol­i­cy­mak­ers lit­tle oppor­tu­nity to develop such a high-risk strat­egy. That does not, how­ever, keep our mon­e­tary pol­icy Keynesian-wannabes from shoot­ing them­selves (and us) in the foot. By con­tin­u­ing with the poten­tially never-ending quan­ti­ta­tive eas­ing that involves buy­ing var­i­ous debt instru­ments over time (of late, mort­gage backed secu­ri­ties, but also from time to time, U.S. Trea­sury secu­ri­ties), the Fed hopes to stim­u­late spend­ing via rock-bottom inter­est rates. Is this pol­icy get­ting to be too much mon­e­tary stim­u­lus? A Fed gov­er­nor recently sug­gested, no, it is not and the Fed has lots of room to do more of the same as time progresses.

At some point, some might inquire why the Fed con­tin­ues to fol­low the same poten­tially self-destructive path of mon­e­tary eas­ing if actual eco­nomic out­comes dif­fer tremen­dously from their own fore­casts. Within the past few weeks Amer­i­cans may have got­ten an answer.

Accord­ing to reported com­ments from at least one Fed gov­er­nor, the rea­son why low inter­est rates have not worked as adver­tised is because of baby boomers. Those peo­ple born between 1946 and 1964 have not been bor­row­ing and spend­ing as the Fed thinks they should have and so mon­e­tary pol­icy effec­tive­ness has been short-circuited.

Not bad pol­icy; bad baby boomers. One has to won­der if a rolled-up news­pa­per is far behind. Bad baby boomers; bad, bad, bad!

Dr. James New­ton serves as Chief Eco­nomic Advi­sor to Com­merce National Bank and is an aux­il­iary fac­ulty mem­ber in eco­nom­ics and sta­tis­tics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not nec­es­sar­ily reflect those of Com­merce National Bank or OSU-Marion/Newark.

Posted by Jim Newton on Nov 27 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.