Monday, March 16, 2009

Emperor Keynes Has No Clothes

Economist Russell Roberts explains nicely why Keynesianism (at least as currently advocated) is "silly pseudo-science":

What did Keynes really mean? It's hard to say. His masterwork is a bit opaque and has been interpreted by many generations of acolytes.

In the current environment, we are told that consumers aren't spending so aggregate demand has fallen. (This is typically discussed as if the reason for this drop is irrelevant). Therefore government must step in as the spender of last resort. This was the defense of the so-called stimulus package of $787 billion. Those who defended it did not defend it on the merits of what was in it, but rather simply on its magnitude. And many of those defenders (including Paul Krugman and Robert Reich) said it was not big enough.

Their basic argument is Keynesian in nature—that aggregate demand, C [consumer spending] + I [investment spending] + G [government spending], must be boosted up to its former level and that this can be achieved through an increase in G. And according to the Administration (and the study it produced written by Jared Bernstein and Christina Romer), every dollar of government spending would produce 1.57 (or was it 1.54?) dollars of income.

The presumption is that it does not matter what G [government spending] is spent on. The most important thing is to get spending into people's hands so that they will in turn spend it and the multiplier will kick in.

The presumption is that the multiplier is a constant. It does not matter how G is financed. It does not matter what G is spent on. It does not matter why C [consumer spending] is down. G just needs to go up. This is silly pseudo-science.

The presumption is that if G goes up, C will stay unchanged. This ignores any possibility that people will be aware that their taxes are going to go up very dramatically in the future and they will do nothing in response.

The presumption is that the borrowing or printing of money to finance the increase in G will have no effect on aggregate demand.

The presumption is that the people who get the money from the government will spend it rather than save it.

These last points are empirical questions. Actual estimates of the multiplier are all over the map. We don't have a lot of evidence on either side that is reliable. Anecdotal evidence is generally restricted to World War II on the encouraging side and Japan's recent experience on the discouraging side.

I have argued that economists generally came down on one side or the other of the stimulus package based not on their economic understanding but on their political and philosophical biases. I still believe that. I think we're in macroeconomically uncharted territory. [Emphasis added.]

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