The Economist (magazine) blog is schizophrenic this week. On the one hand, it does a drive-by ad hominem attack on Amity Shlaes, calling her "empirically challenged" without actually mentioning any facts she got wrong in her book, The Forgotten Man. On the other hand, the blog has a post today that points out the fallacy in the idea of Keynesian growth. The fallacy of Keynesian growth is the basic idea of The Forgotten Man, by the way, a much bigger story than spending multipliers.
Clearly, the global economy is in a deep recession, and the Democratic monopoly in power in DC is moving boldly to address it. Indeed, the moves have been so bold that Republicans are essentially united in opposition. This isn't just partisanship, as there were many centrist Democrats voting against the recent stimulus bill, and already vocal Democratic defections from other economic plans coming from the White House (witness the quiet multi-month delay in consideration of the Orwellian "Employee Free Choice Act"). These are simple facts. Unfortunately, the heated politics of the worsening recession have boiled over to the economics, and made for some nasty exchanges.
One of the core concepts being debated is whether fiscal stimulus is an effective remedy for recessions. As Harvard economist Greg Mankiw has recently and repeatedly observed, this idea was out of favor among mainstream academic economists in recent years. Unfortunately, the very word "Keynes" has become, in political conversation, an invitation to draw battle lines and simplify discourse entirely. Naturally, we all struggle to make technical economics accessible to the lay reader (i.e. the policymaker), but discussions of Keynesianism are particularly cartoonish. It is unhelpful enough when politicians want to believe that everything Keynes did, said, wrote, researched was somehow socialist. It's even worse when academics (Brad DeLong, are you listening?) play on those same cartoonish sentiments.
Defenders of the stimulus want to confuse Shlaes history book into some kind of wild-eyed hostility to all things wise and wonderful written by Keynes and every great economist since. She's no economist, they thunder! Consider BigPicture which ridiculed Shlaes last November as "economically clueless" and a "no-nothing" (know kidding) for describing a recession as two quarters of GDP decline, which is exactly what Ph.D. economists do all the time as a non-technical rule of thumb.
Advocates of activist policy are really guilty not just of a war against apostates, but distorting their own prophet's words. They are turning Keynes into a caricature: all spending is good spending! Cartoon Keynesianism sees all politics as a struggle over the size of G, government. This cartoon is offensive and seems like a willful distortion with ulterior motives.
In truth, Keynesian stimulus need not be government spending, it can also be tax cuts. Shocker! I, for one, support the basic Keynesian idea of automatic stabilizers in place and wish we had more built into the tax system. Yet too many voices in the punditry space lump all tax cuts in the capitalism/Republican side and all spending in the socialism/Democratic side. It's insulting to both sides, and worse it marginalizes the more important conversation about growth policy. Here's the honest way economists should be talking about any short-term Keynesian spending plan: "Recovery? Maybe. Growth? No."
That conclusion, in fact, is from the Economist blog. Quote: "Stimulus can help with recovery, but it can't do much to aid reformation—indeed, it could retard structural transitions." Keep in mind that not all economists are even that kind to stimulus policies. Research by UCLA economists Harold L. Cole and Lee E. Ohanian in 2004 conclude FDR's policies extended the Great Depression, saying: "We found that a relapse [into another long Depression] isn't likely unless lawmakers gum up a recovery with ill-conceived stimulus policies." A 1999 paper by the economists for the Minneapolis Fed reviewing the Great Depression opens:
[T]heory predicts an extremely rapid recovery that returns output to trend around 1936. In sharp contrast, real output remained between 25 and 30 percent below trend through the late 1930s.We conclude that a new shock is needed to account for the Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly and the distribution of income.
A lot of good theory works on paper, but is humbled by reality. This is what happened to Old Keynesianism, and is why modern teaching in grad schools is now done under the banner of Neo- or New Keynesianism. The identity Y = C + I + G + NX is simply too crude to tell us anything about how an economy grows. The crudest interpretation, and dumbest, was followed by Washington policymakers for decades and imagines the national income identity can be managed by fiscal policy. Whether such policy is sustainable is irrelevant. And yet, history tells us that constantly pushing G to manage Y causes an uncontrollable price inflation. Uncontrollable in the Keynesian paradigm, that is. The whole framework was superseded by expectations macro and validated by Volcker when he stopped Keynesian inflation of the 1970s with the 1980-82 monetarily induced recession.
The defenders of Cartoon Keynesianism want to believe their framework had a similar validating experience, which was the New Deal's curative power over the Great Depression. The simple history taught in most high schools today (and non-economics college courses) is that FDR's expansion of government saved the national economy. That's just not true.
There are four presidential names being bandied about: Hoover, Roosevelt, Bush, and Obama. The cartoon story says that Bush like Hoover wrecked the economy with laissez-faire extremism and that Obama like Roosevelt will tame capitalism's failure with strong government action. The reality is that government spending and budget deficits under President Bush were massive, while Hoover is infamous for raising tariffs in 1930 as well as the top income tax rate from 25 to 63 percent in 1932. So Hoover wasn't really laissez-faire in his policies, and Bush wasn't either. Every president - especially Obama - offers a mixed bag of tricks that defy labels, especially old ones.
So why did Free exchange go after Amity Shlaes? For starters, it was echoing a long and current piece by Jonathan Chait in the New Republic, whose purpose is to paint modern Republicans as little Hoovers. Except for the little things like tax rates and free trade, which he ignores, choosing to selectively make a case about somebody else making a selective case. My theory is that this is part of a larger reckoning.
Chait wants his readers to think the Amity Shlaes is an outlier (and not the smart kind). But Chait -- perhaps because he also has no economics degree -- makes false claims about consensus in the profession, such as "the essential framework constructed by Keynes--that recessions are caused by a failure of demand, and that at the very least government should not respond to an economic slowdown by paring back its largesse--is no longer in dispute." This is just wrong. It may comes as some surprise that a 1995 survey of economic historians published in the Journal of Economic History said this:
On top of the profession's lack of agreement about the genesis of the Great Depression, there is a disagreement about the effect of the New Deal. In fact, the economists in the sample are almost evenly divided on the question of whether or not when taken "as a whole, government policies of the New Deal served to lengthen and deepen the Great Depression."
This is important not just to make the point that partisans on the Left (and Right) are mean, dishonest jerks. The global recession is very real, so when even the Economist (magazine) falls into this shallow smear game, I get worried that we are collectively taking our eye off the ball. If your goal is rip-roaring growth, fixing banking, fixing mortgages, or a real cure for poverty, a debate about stimulating the short-run economy is irrelevant. At best, another trillion in G arrests a couple points of GDP decline for a couple years if you believe the macro sim models. Add up all the new plans, and you get annual trillion-dollar deficits for the next decade, according to the Brookings Instituion.
Rather than take on half of the economics profession, or Brookings, or just engage in a serious discussion of growth policy, the partisans have instead decided to target Amity Shlaes for writing a history book two years ago about the New Deal and FDR. Ironically, if you understand her title, The Forgotten Man is not about macro stabilization theory, but about the unprecedented scope of powers that were centralized in 1930s America, running roughshod over the Constitution and the middle class Americans who pay for grand plans. This, too, is fact even for fans of big G. But I guess describing facts makes you an enemy of the state and its toadies.
What is really at stake is a year of budgetary reckoning, which I now believe will become a decade of reckoning. The crisis of big entitlement promises is about to clash with the limits of taxation. Shouting down Amity Shlaes is just a warm-up.