The economic philosophy of John Maynard Keynes had a brief revival after the financial crisis of 2008. Desperate politicians tried to save the global economy–and their own jobs–by launching stimulus plans to plug an “output gap,” the gaping hole that had opened up amid plunging GDP and massive de-leveraging.
Stimulus had varying degrees of success in Germany (yes), the US (partly), and China (yes in the short term but maybe not in the long run).
But fiscal issues quickly took over as governments ran up huge debts. Especially in the UK and the euro zone, austerity has ruled, and countries like Greece, Ireland, Portugal, Spain and Italy have been forced to enact painful spending cuts and tax increases to avoid default and keep the euro alive.
Now we’re seeing a backlash. Weak economies—Greece’s GDP has dropped sharply and Spain’s unemployment rate is a Depression-level 24%–have spurred popular outrage and some rethinking about whether austerity is the answer.
Enter the Keynesians with “helpful” advice. Here’s Lawrence Summers, former Treasury Secretary and once President Obama’s top economic adviser, in The Washington Post:
The cause of Europe’s financial problems is lack of growth. In any financial situation where interest rates far exceed growth rates, debt problems spiral out of control. The right focus for Europe is on growth; in this dimension, increased austerity is a step in the wrong direction.
And Christina D. Romer, former chairman of President Obama’s Council of Economic Advisors, writing in The New York Times:
…Austerity is uniquely destructive right now. Indeed, because of the harsh effect of budget cutting on growth, debt-to-G.D.P. ratios in Europe have continued to rise.
The core of a more sensible approach is to pass the needed budget measures now, but to phase in the actual tax increases and spending cuts only gradually — as economies recover. To use economists’ terminology, the measures should be backloaded.
And then, of course, there’s the Keynesian’s Keynesian, Paul Krugman, the Nobel Prize-winning economist and New York Times columnist. Krugman, a vocal supporter of a much bigger stimulus package in the US ($1.2-$1.3 trillion vs. the $800 billion plan that passed) isn’t shy about saying “I told you so” in so many words:
Spain’s fiscal problems are a consequence of its depression, not its cause.
Nonetheless, the prescription coming from Berlin and Frankfurt is, you guessed it, even more fiscal austerity.
This is, not to mince words, just insane. Europe has had several years of experience with harsh austerity programs, and the results are exactly what students of history told you would happen: such programs push depressed economies even deeper into depression.
All three, particularly Romer and Krugman, want more government spending, especially by Germany, and a looser monetary policy by the European Central Bank. (Strictly speaking, the latter is out of Milton Friedman’s playbook, not Keynes’s, but the Keynesians will take it.)
Here’s the problem. Global economies probably could use some more stimulus, but debt is mounting dramatically. The needs are endless and resources are limited, and so are nations’ credit limits.
And though all the trillions in reserves central banks have put on banks’ balance sheets haven’t caused inflation yet, I wouldn’t want to push it.
The ultimate Keynesian policy, World War II, ended the Depression because of massive borrowing and a troop mobilization that removed 16 million people from the labor force. In peacetime, such measures would be impractical and dangerous.
Our own stimulus package was poorly constructed—too much for tax cuts nobody knew about and subsidizing public service workers, which only postponed their agony.
The valuable, workable part—building infrastructure—was less than a third of the plan. It should have been the whole thing.
So, the Keynesians are right in pointing out the problems with austerity and recommending that spending cuts and tax increases be phased in wherever possible. But as for more stimulus, that train left the station a while ago.