A response to the essay “Why Not Keynes?” by James K. Galbraith.
James Galbraith has provided a provocative essay that incorporates—in an almost stream-of-consciousness style—his commentary on topics ranging from David Ricardo to Robert Rubin. I’ll concentrate on two of his themes.
First, it’s dubious for Galbraith to claim that only “False Keynesians” came to power in the Obama administration. Christina Romer, the head of Obama’s Council of Economic Advisers, relied on Keynesian “multiplier” analysis to generate the now-notorious predictions of what would happen to unemployment with and without the stimulus package. (To refresh the reader’s memory: The incoming Obama team said that its $787 billion stimulus would keep unemployment from breaking 8 percent, whereas failure to pass a stimulus package might allow unemployment to rise as high as 9 percent. In reality, of course, the American people got the stimulus package, and unemployment shot above 10 percent.)
Galbraith and other outside Keynesians—Paul Krugman comes to mind—were calling for a bigger stimulus from the beginning. But free-market economists who were arguing against the stimulus had their predictions validated as well, at least in regards to unemployment and GDP growth. The administration’s Keynesians had to contend, “Gosh, the economy was worse than we realized!” rather than drawing the more obvious conclusion: “Gosh, our ‘medicine’ actually made the patient sicker!” Galbraith can suppose that a dose of medicine twice as large, for twice as long, would worked—but the evidence is as consistent with the opposite claim.
Any time politicians get involved in something, they are going to dull the blade of academic purity. Even so, the Obama administration was pretty radical and pointy-headed as far as these things go. One can agree with Galbraith that Obama didn’t live up to expectations that he would be the next FDR, but the very fact that his fans had such hopes is telling.
Galbraith seems to be arguing that the U.S. is stuck in a long slump because Obama wasn’t really radical and didn’t implement a new New Deal. In response, foes of big government can point out that the economy thus far isn’t nearly as bad as it was under the old New Deal. Liberals claim FDR “got us out of the Depression,” but he was first elected in 1932. What would history have to look like for us to conclude that FDR prolonged the Depression?
Galbraith focuses on what economists call “nominal expenditures”—how many dollars are flowing around the economy, rather than the output of goods and services that are useful to consumers. He directs our attention to the national income accounting tautology, which equates Gross Domestic Product with the sum of consumer spending, business investment, government spending, and spending by foreigners on net exports.
If government spending goes down, then that “hole” must be filled by something else, such as consumer or business spending, lest Gross Domestic Product fall. It is true, as Galbraith argues, that in the current environment consumers and businesses are not eager to make massive new purchases.
But who cares if the dollar value of “Gross Domestic Product” goes down? If prices fall even more, then Americans’ standard of living goes up. For example, if the Tea Party activists actually held Republicans’ feet to the fire and Uncle Sam didn’t raise the debt ceiling, then the government would have to slash $750 billion or so from this year’s spending to avoid default on the existing debt.
That would mean that there was a sudden loss of $750 billion in income to various people in the economy. A large part of it would probably be made up by income generated in the private sector, as the government’s deficit disappeared and people expected lower future tax burdens. But even if it didn’t, so what? The quantity of skilled workers, raw materials, and machine tools wouldn’t decrease just because Uncle Sam started living within his means. After prices adjusted downward, Americans would find they could buy more with their lower incomes.
Switching from a Keynesian to an Austrian view of the economy, it becomes clear that the government and Federal Reserve have only prolonged the slump. Just as Alan Greenspan didn’t really fix the problem of the dot-com crash by inflating the housing bubble, neither has Ben Bernanke solved the problem of the housing crash by creating more than $1 trillion out of thin air with which to buy government debt and “toxic” derivative assets. Deficit spending makes things worse because the politicians transfer resources out of the beleaguered private sector and direct them into boondoggle projects.
James Galbraith is correct when he observes that Obama has not ushered in a second New Deal, at least not yet. For that, Americans can all be grateful.
Robert P. Murphy is an economist with the Institute for Energy Research.