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Keynes Rules From the Grave

Mises Daily: Tuesday, January 21, 2003 by

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Everyone is at work on a "stimulus plan" for doing something about the recession. But the much-publicized disagreement between the Republicans and Democrats is not about economic theory as such. There has been no critical thinking applied to the subject of why the recession, the longest in the postwar period, continues. Rather, the disagreement is about which levers to pull when, and who should get the benefits.

All this is evidence that Keynes rules us from the grave. Popularized and reduced to sound bites, the fallacies are far easier to detect than in Keynes' impenetrable prose from his 1936 treatise that first resurrected ancient fallacies and garbed them in the language of science.

The underlying idea in the Keynesian tradition is to attribute the length of the recession to insufficient effective demand, so it is up to government to give the economy a kick-start, change public psychology, spend money on anything and everything, stop the money hoarding and start the buying, inflate a bit here and there, drive down interest rates, run deficits for a while, and fool the workers into thinking they’re getting raises though their real wages are falling.

That's the traditional mix of policies that has been employed during every recession between the early thirties and the current day. Bush clearly subscribes to this view. After his meeting with a group of economists who should know better, he said a feature of his plan is that it "recognizes that money in the consumers' pocket will help grow this economy." In fact, the White House says that the first principle of its economic program is to "encourage consumer spending."

Just think about this. Let's say that every one one of us emptied our bank account today and just bought something. And let's say we used all our assets and leveraged them to the hilt to borrow as much money as possible, and then spent that. What would happen? Well, shelves would empty and prices would go up and the business pages would roar with approval. But what about tomorrow? There are no savings left to fund new projects that would be undertaken after this little boomlet. Products on shelves would languish. Long-term projects would have no customers. We would have spent ourselves straight into recession again. This plan boosts the economy in the same way that an amphetamine boosts one's mood. It's an illusion that must end.  

There is no evidence that this path has ever worked to pull an economy out of recession. And if you look at consumer debt, it seems that my little allegory of spending mania isn't far from the reality.

Personal consumption figures have topped any in history but still no recovery:

While any non-socialist should cheer a tax cut—though if government spends money, it has to come from somewhere—let's not pretend that the Bush administration is driven by the desire to free the economy from the taxman's shackles. If every dime saved by taxpayers were put into savings accounts, the administration would consider its plan a failure. The idea is to get people to spend ever more money. Perfunctory tax cuts are the type of Keynesian policy Republicans like because it dovetails nicely with GOP slogans about small government. 

The idea of eliminating taxes on dividends in particular is designed to boost demand for the stocks that pay them (typically older companies with more political connections). And where is the money that will flow to stocks coming from? Most likely from investments that currently yield interest payments—at least that's the theory. If the purpose were merely to boost the business sector and eliminate double taxation, that could be accomplished by a reduction of corporate taxes, an idea that was ruled out early on. 

Another idea that made a brief appearance in late December was to create a payroll tax holiday. The Democrats favored this idea because it would benefit their constituents, but the Republicans rejected it out of hand, proving once again that they have no general interest in making government cheaper for average Americans. The idea was quickly dropped when everyone realized the dangers associated with creating a precedent that would allow people not to pay a tax. After all, if a tax holiday is good for the economy, why not make it permanent? 

But will draining savings and boosting spending cure what ails us? No, because the US economy is, in fact, not suffering from some blight of insufficient aggregate demand. It is suffering from the malinvestments of the previous boom, when the capital-goods sector expanded disproportionately to what savings could justify, an imbalance brought about by the Federal Reserve's loose money policies of the late nineties. 

But you won't read about this in the literature of the Keynesians who still rule the roost in Washington. For further proof, look at the headlong rush to extend unemployment benefits on into the future. This is completely contrary to what economic reality should dictate. In a recession with unemployment, wages need to fall in real terms. But an ironclad tenet of Keynesian economics is that this must never be allowed to happen. By this one error, the Great Depression in the US and Britain was prolonged by many years. 

There are several undeniable realities of a recessionary environment. Wages tend to fall. Businesses tend to be liquidated. Resources are withdrawn from investment and put into savings. Consumers spend less. Stock prices fall. All of these tendencies may seem regrettable but they are necessary to bring all sectors back into realistic balance with each other. It can only do harm to fight these developments—via policies that promote debt and gin up the business sector—as Japan has done for ten years and Washington is doing again today. 

Even if the first stimulus held out the prospect for success, Washington has worked for 18 months to cripple economic growth through mind-boggling spending, aggressive protectionism, and attacks on the personal liberty that undergirds free enterprise. The prospect of war and all it entails is the Sword of Damocles threatening American prosperity (not an additional spending boost, as the Bush administration seems to believe). All this drains power and resources from the private to the public sector, the last thing an economy in recession needs. 

Might the economy be in recovery mode had Washington not engaged in these destructive acts? Perhaps. It is a general rule of public policy that when government acts to fix a problem, it makes the targeted problem worse and creates a few more in the process. 

By all means cut taxes! Anytime, anywhere! But one must also cut spending if the goal is to reduce the overall burden of government (and that is clearly not the goal). One must also be prepared for the possibility that citizens will save this money, as they probably should, rather than spend it. In the current DC hysteria, however, it is Keynesianism and not clear economic thinking, that rules.


Llewellyn H. Rockwell, Jr. is president of the Mises Institute in Auburn, Alabama, and editor of LewRockwell.com. Send him MAIL, and see his Mises.org Daily Articles Archive.