Washington Post
December 19, 2011
Bye-Bye Keynes?
By _Robert Samuelson_
(http://www.realclearpolitics.com/authors/?author=Robert+Samuelson&id=14456)
"Practical men, who believe themselves to be quite exempt from any
intellectual influences, are usually the slaves of some defunct economist."
-- John Maynard Keynes, 1936
WASHINGTON -- The eclipse of Keynesian economics proceeds. When Keynes
wrote "The General Theory of Employment, Interest and Money" in the mid-1930s,
governments in most wealthy nations were relatively small and their debts
modest. Deficit spending and pump priming were plausible responses to
economic slumps. Now, huge governments are often saddled with massive debts.
Standard Keynesian remedies for downturns -- spend more and tax less --
presume
the willingness of bond markets to finance the resulting deficits at
reasonable interest rates. If markets refuse, Keynesian policies won't work.
Countries then lose control over their economies. They default on maturing
debts or must be rescued with loans from friendly countries, the
International Monetary Fund (IMF), government central banks (the Federal
Reserve, the
European Central Bank) or someone. There are other reasons why Keynesian
policies might fail or be weakened. But they pale by comparison with the
potential veto now posed by bond markets. Ironically, the past overuse of
deficits compromises their present utility to fight high unemployment.
There is no automatic tipping point beyond which a country's debt -- the
sum of past annual deficits -- causes bond markets to shut down. But _Greece_
(http://realclearworld.com/topic/around_the_world/greece/?utm_source=rcw&utm
_medium=link&utm_campaign=rcwautolink)
, Portugal and Ireland have already reached that point, with gross debt in
2011 equal to 166 percent, 106 percent and 109 percent of their national
incomes (gross domestic product), according to IMF figures. Heavily indebted
_Italy_
(http://realclearworld.com/topic/around_the_world/italy/?utm_source=rcw&utm_medium=link&utm_campaign=rcwautolink)
and _Spain_
(http://realclearworld.com/topic/around_the_world/spain/?utm_source=rcw&utm_medium=link&utm_
campaign=rcwautolink) could lose access to bond markets.
Thankfully, the _United States_
(http://realclearworld.com/topic/around_the_world/united_states/?utm_source=rcw&utm_medium=link&utm_campaign=rcwautolin
k) is not now in this position. Interest rates on 10-year Treasury bonds
hover around 2 percent; investors seem willing to lend against massive U.S.
deficits. Just why is unclear. It's not that U.S. budget discipline is
noticeably superior. Economists Pedro Amaral and Margaret Jacobson of the
Cleveland Federal Reserve recently compared U.S. budget performance against
that
of the weak European nations.
In 2012, the American budget deficit is projected at 7.9 percent of GDP;
Greece's is 6.9 percent; Italy's 2.4 percent. In 2012, U.S. government
borrowing -- the deficit plus renewing maturing debt -- is estimated to be 27
percent of GDP; Greece's is 24 percent; Ireland's 19 percent. On the plus
side, the U.S. debt-to-GDP ratio is smaller than Europe's worst. Also, a "safe
haven" effect -- reflecting the size of the U.S. economy and past political
stability -- contributes to America's good fortune.
Considering this, some economists urge more "stimulus." In a paper,
Christina Romer -- former head of President Obama's Council of Economic
Advisers
-- argued that scholarly studies support the administration's view that its
$787 billion stimulus in 2009 cushioned the recession. Another big stimulus
"would be very helpful ... to really create a lot of jobs."
I am less sure. For the record, I supported Obama's stimulus -- though
disliking some details -- and, under similar circumstances, would again. The
economy was in a tailspin; the stimulus provided a psychological and spending
boost. But how much is less clear. As Romer notes, estimating the effect
is "incredibly hard." For example, the Congressional Budget Office's
estimate of added jobs from the stimulus ranged from 700,000 to 3.3 million
for
2010.
Suppose a new stimulus -- beyond renewal of the payroll tax cut -- did
succeed at significant job creation. By piling up more debt, it would still
risk aggravating a larger crisis later. There is no long-term plan to curb
deficits. Americans seem to think they're invulnerable to a bond market
backlash. Economist Barry Eichengreen, a leading scholar of the Great
Depression,
is dubious:
"Given low interest rates and the still-weak U.S. economy, it will be
tempting for the U.S. government to continue running deficits and issuing
additional debt. At some point, however, investors will recognize this behavior
for the Ponzi scheme it is. ... If history is any guide, this scenario will
develop not gradually but abruptly. Previously gullible investors will
wake up one morning and conclude that the situation is beyond salvation. They
will scramble to get out. Interest rates in the United States will shoot
up. The dollar will fall. The United States will suffer the kind of crisis
that Europe experienced in 2010, but magnified."
Governments have ceded power to bond markets by decades of shortsighted
behavior. The political bias is to favor short-term stimulus (by lowering
taxes and raising spending), which is popular, and to ignore long-term
deficits
(by cutting spending and raising taxes), which is unpopular. Debt has
risen to hazardous levels, undermining Keynesian economics as taught in
standard texts.
Were Keynes alive now, he would almost certainly acknowledge the limits of
Keynesian policies. High debt complicates the analysis and subverts the
solutions. What might have worked in the 1930s offers no panacea today.
--
Centroids: The Center of the Radical Centrist Community
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Radical Centrism website and blog: http://RadicalCentrism.org
