Nov. 19 (Bloomberg) — Every crisis has its heroes. For months now we've all been hearing about Walter Bagehot, whose 19th-century injunction to lend "freely" in a panic was cited by the Federal Reserve in its bailouts.
Now another Englishman, John Maynard Keynes, has been pulled on the stage. Keynes taught that spending, especially spending by consumers, is the way out of a slowdown. From last summer's small stimulus checks to the infrastructure projects under consideration by President-elect Barack Obama and congressional Democrats, almost everything the government has done or wants to do is justified by Keynes.
That's problematic. For Keynesian solutions often fail to deliver good or even acceptable results.
The limits start showing up with the tiniest of stimuli, those government checks Americans received in the mail last spring. The idea was that having the cash would cheer up consumers so that they would start shopping again, helping retailers. That in turn would revive wholesalers, shippers, suppliers — on up the production line.
But that stimulus failed, as the University of Michigan's Joel Slemrod and Matthew Shapiro noted. Interviews with consumers showed that only a fifth said they would spend their cash.
Savings rates tracked by the Bureau of Economic Analysis seemed to confirm that, with personal savings rates rising about the time the checks were mailed. Slemrod and Shapiro weren't surprised. They have spent much of their careers documenting failed stimulus plans. Their study of the effects of the 2001 Bush stimulus was so damning you might think that Washington would never repeat it. But Washington did.
One reason consumers don't want to spend is that they don't react instantaneously, as Keynes posited they would. They follow, rather, the theory of an economist oft-presented as the anti-hero of the moment, Milton Friedman. Friedman's permanent-income hypothesis said that consumers consider their entire future, and not just their mood, when they shop. If expectations of lifetime earnings drop, then so will spending. That too tracks reality. Many of us are beginning to wonder if we will ever get back the price we paid for our houses.
But what about the larger stimulus plan, the kind President-elect Obama is considering? The idea is to revive Franklin D. Roosevelt's New Deal and create jobs by building new bridges or roads. Obama has also spoken of a kind of corps for the young, which, you get the sense, might be involved in some of these projects. That comes out of the New Deal and FDR's Civilian Conservation Corps.
Keynesians would say such moves will bring the economy to life, creating jobs and replacing crumbling infrastructure.
Others would argue that the productivity gains to be had from an infrastructure program also are significant. That's the view of scholar Alexander Field, who studied the New Deal and found that the private sector benefited enormously from its construction projects. After all, when the government supplies a bridge from Point A and Point B, the private trucking company can deliver goods between A and B faster. The project may be public, but its "spillover" yields profits too.
The best evidence for the infrastructure spending case comes not from a Democrat but from a Republican: Eisenhower's National Highway System. The rebuttal there is that emphasis on government in the 1950s made the decade a dull one that stifled innovation.
And you also have to ask: What is lost when Washington puts resources into such road projects? One problem is that a stimulus project and an earmark are dangerously similar. Sometimes the government will waste its resources on bridges that truckers won't use — the new Bridges to Nowhere.
But the most telling fact about the new rush to spend is that its advocates have insisted on invoking the New Deal. They tend to gloss over the period when the phrase, "We are all Keynesians now," was actually first uttered: the mid-1960s. (Uttered by Friedman, in fact, though he meant only that we all work in the terms of the Keynesian lexicon.)
The Great Society of that period was the ultimate Keynesian experiment, and it didn't work very well. One example is VISTA, the domestic Peace Corps from that period. VISTA had mixed results and has been renamed and reshaped many times since. Its full name, "Volunteers in Service to America," fits perfectly as a description of the youth programs the Obama camp has described.
The leaders of the 1970s and 1980S — Nixon, Ford, Carter, Reagan and Paul Volcker — were left to live with the Great Society aftermath. The jobs that Keynes emphasized were AWOL: America became accustomed to high levels of unemployment.
Were they alive, both Bagehot and Keynes would defend themselves. Bagehot, for example, would say that he saw the central bank as the lender of last resort, not the lender of first resort. Keynes would note he operated in a gold-standard world, or tried to, not in our free-float-except-for-China arrangement.
The important thing to recognize is that the record of actions taken in economists' name is mixed. Try this sentence: We're not all Keynesians now.
© Copyright 2008 Bloomberg
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