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In December 2008, the then German Finance Minister, Peer Steinbrück, injected a new phrase into macroeconomic debate — "crass Keynesianism". In a Newsweek interview, he warned of the risk of "burning money without significant effects and in the end having a budget weighed down with even more debt". 

Steinbrück's most egregious target was Gordon Brown, who was in the final phase of an almost decade-long public-spending binge. But his wider assault was on an idea devoutly held in nearly all US and British university economics departments. This was the notion, first propounded by Keynes in his 1936 General Theory, that increases in government expenditure and the resulting budget deficits stimulate economic activity. 

The American Keynesians retaliated. In the New York Times, Paul Krugman invoked Keynes's claim that a so-called "injection" of public expenditure raises aggregate demand by a multiple of itself. The Nobel laureate thought that "a huge multiplier effect" was indeed at work, but "unfortunately what it's doing is multiplying the impact of the current German government's boneheadness". 

Krugman had, and retains, much influence over Barack Obama. Within a few weeks of Steinbrück's verbal offensive, the newly-elected President Obama signed the American Recovery and Reinvestment Act. According to the latest Economic Report to the President, this was "the signature element in the Administration's policy response to the crisis". The "cost" was estimated at $787 billion and described as "the largest countercyclical fiscal action in American history". 

It is now more than 18 months since the Steinbrück-Krugman exchange, a period usually regarded as long enough for fiscal measures to have an impact. So who's been right? The critical variable is the unemployment rate. The Economic Report is right that the current burst of additional public expenditure is unprecedented. The increase in the structural budget deficit between 2007 and 2010 was six per cent of gross domestic product, far in excess of anything seen in the 1930s or in the early 1980s, which saw the previous big post-1945 recession. If a fiscal boost of six per cent of GDP, along with the alleged "multiplier" effects, has been unable to cut American unemployment, something is wrong with Keynesian theory. 

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William Peden
October 27th, 2010
3:10 PM
TequilaKid, Do I trust banks to be totally rational in their lending? No. Do I trust the Venezuelan government, which cannot even keep food from rotting in the fields, to do any better? No. Do I expect ANY government to do any better? No. Politicians have their own incentives, which mean that their "investment" has less to with future growth and more to do with political profits, particularly by "picking winners" on the basis of special interest groups. This is why the record of state intervention in investment is so poor. After all, do we really want the people behind the expenses scandal having the power of life or death over any business in the country? At least, if one bank is too stupid to lend to a great entrepreneur, he can go to another. What does one do with a state monopolist? Monopolies should always be avoided. Tim Congdon and Steinbruck get it: the problem is monetary, not Real. Until we start getting a sensible, pro-growth, non-Japanese-style monetary policy out of the United States, we're not going to get a substantial recovery.

October 26th, 2010
4:10 PM
Pardon a monetary ignoramus like me butting in, but if the financial crisis was caused by a dysfunctional financial services sector -- which I think is a widely shared opinion -- shouldn't you look into the possibility that that very same dysfunction is at the root of this failure of Keynesian policies? Wall Street has consistently failed to direct funds toward productive investment, for example by preferring to speculate with the money instead of lending it to eager entrepreneurs. I think it is reasonable to suspect that the Wall Street hyenas are back to their old tricks. After all, the bulk of the stimulus funds was funneled to the banks, was it not? Perhaps Keynes unrealistically assumed rational behavior by holders of financial capital. By the way, there was something in the news about President Cesar Chavez nationalising Venezuelan banks. Hmmm.

W. Peden
October 26th, 2010
11:10 AM
Excellent article. I know of no case where, when monetary policy has gone one way and fiscal policy has gone the other, that the performance of economies has followed the route set out by fiscal policy. On the other hand, there are plenty of examples (like the 1981 budget or the 1930s) where the two diverged and things went the way of monetary policy. This is not surprising: monetary policy is the "final mover" in an economy and any effects of fiscal policy can be counteracted by monetary policy. The Keyensian loyalty to fiscal stimulus (curious, considering that Keynes talks about public works rather than fiscal policy, but as Tim Congdon has pointed out Keynes and Keynesianism are different) is purely political: fiscal stimulus is a give-away orgy where people get to do good with money without, supposedly, even having to take it from someone else. The crisis has confirmed the basic doctrines of monetarism: fiscal stimulus is ineffective by itself, it is not possible to get back to trend NGDP without a sustained increased in the supply of money, and a precipitous drop in the supply of money causes deflationary monetary conditions. The Germans, once again, have showed that nominal crises require nominal solutions.

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