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Keynesian Cons

Much as the supply-siders rail against economic stimulus, they buy the basic argument.

Keynesian economics is back. Government spending to stimulate the economy is all the rage and has won the day in Congress. Of course, conservatives are uneasy. “It’s hardly a secret that Obama is a Keynesian and that he is staggeringly untroubled by the consistent failures of Keynesian policy before and since the New Deal,” David Limbaugh writes at Townhall.com. Dick Morris and Eileen McGann add, “There are very few economists who really buy into Keynesian theory anymore. Instead, the idea of ‘rational expectations’ has taken its place. The difference between the two approaches is essential to understanding why Obama’s stimulus package won’t work.”

Indeed, you would be hard-pressed to find a conservative who admits to being an orthodox Keynesian, conservatives having joined the Church of the Supply Side many years ago. But though Keynesianism tends to be associated with big-government “liberalism”—in its original form, liberalism stood for small government in all realms—many who take Keynes’s approach to economics are nevertheless self-identified conservatives. In practice, “conservative Keynesian” is not a contradiction in terms.

What is a conservative Keynesian? While there may not be a formal definition—mainstream Keynesianism has many nuanced variations—it is fair to say that a conservative Keynesian 1.) looks at the world in terms of macroeconomic aggregates, that is, total output, total employment, and most especially aggregate demand; 2.) sees government fiscal policy as a way to improve those aggregates; and 3.) embraces or at least tolerates deficit spending and inflation in the short run. That much is pretty close to standard Keynesianism. What makes one a Keynesian of the Right is a preference for tax cuts over government spending, although the intention is the same: to put money into the hands of consumers as a way to increase aggregate demand during recessions.

George W. Bush was a model conservative Keynesian. After 9/11, he urged us to shop to keep the economy from falling into a recession. He was also responsible for the 2008 tax rebate—remember those $300 stimulus checks? —which was based on the theory that putting money into people’s hands would boost consumer spending and nip recession in the bud. (It didn’t.)

An astonishing number of the Republicans’ most cherished economic thinkers can be called Keynesians. According to Austrian economist Murray Rothbard, former Fed chairman Alan Greenspan “is, like most other long-time Republican economists, a conservative Keynesian, which in these days is almost indistinguishable from the liberal Keynesians in the Democratic camp. In fact, his views are virtually the same as Paul Volcker, also a conservative Keynesian. Which means that he wants moderate deficits and tax increases, and will loudly worry about inflation as he pours on increases in the money supply.”

Another of these influential Republican economists is Martin Feldstein, a Harvard professor of economics who was President Reagan’s chairman of the Council of Economic Advisers. While Feldstein was a critic of the growing deficit in the Reagan years, today he supports government spending to promote economic recovery. Writing in the Washington Post in October 2008, Feldstein argued that falling home prices are “causing consumers to cut spending, leading to lower employment, lower incomes, and further cuts in consumer spending. Other components of aggregate demand are also falling. The decline in consumer spending will lead to less business investment in plants and equipment.”

Tax cuts wouldn’t work, he said: “The only way to prevent a deepening recession will be a temporary program of increased government spending. … A fiscal package of $100 billion is not likely to be large enough to revive the economy.” In true Keynesian fashion, he added, “While it would be good if some of the increased spending also contributed to long-term productivity, the key is to stimulate demand.” In other words, it really doesn’t matter how the government spends the money. (Keynes said the same: even building pyramids and digging holes would do.)

A few months later, Feldstein made it clear what kind of conservative Keynesian he is: a military Keynesian. (Anyone who thinks World War II ended the Great Depression is a military Keynesian.) In the Wall Street Journal, Feldstein wrote,

As President-elect Barack Obama and his economic advisers recognize, countering a deep economic recession requires an increase in government spending to offset the sharp decline in consumer outlays and business investment that is now under way. … A temporary rise in DOD spending on supplies, equipment and manpower should be a significant part of that increase in overall government outlays. The same applies to the Department of Homeland Security, to the FBI, and to other parts of the national intelligence community.

He even added a Keynesian protectionist twist: “Military procurement has the further advantage that almost all of the equipment and supplies that the military buys is made in the United States, creating demand and jobs here at home.” Feldstein’s plan was not only to help end the recession but to strengthen the American empire.

On the less sophisticated end of the conservative Keynesian spectrum is Michael Gerson, Washington Post columnist and former speechwriter and senior policy adviser to President George W. Bush. According to Gerson, while the stimulus bill that emerged from Congress was “deeply flawed,” it had a “hidden virtue”:

A good portion of the funding is channeled to the poor through programs such as food stamps, unemployment insurance, the child tax credit and the earned-income tax credit. This has a humanitarian justification—unskilled workers and minorities are hurt first and hardest by unemployment. But a focus on the poor has an additional economic justification. Dollars given to the middle class during uncertain economic times are likely to be saved—particularly when the middle class calculates (not unreasonably) that current government largess may require future tax increases. Assistance provided to the poor, in contrast, is used immediately for necessities.

Gerson thus shares the Keynesian animosity toward saving, not realizing that saving is in fact an alternative form of spending—on capital goods and labor, which makes possible the economic restructuring needed after a government-induced asset bubble has burst.

Perhaps the most interesting conservative who has embraced Keynes, albeit critically, is Bruce Bartlett, a Forbes columnist and author of Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy. In his recent column “Does Stimulus Stimulate?” he revisited the Great Depression, especially the secondary depression that began in 1937, when Franklin Roosevelt raised taxes and cut spending and the Federal Reserve (again) contracted the money supply. “The result was an economic setback that didn’t really end until both monetary and fiscal policy became expansive with the onset of World War II,” he wrote. “At that point, no one worried any more about budget deficits, and the Fed pegged interest rates to ensure that they stayed low, increasing the money supply as necessary to achieve this goal. It was then and only then that the Great Depression truly ended.” In another article, Bartlett wrote, “[I]n terms of fiscal policy [before war spending kicked in], Roosevelt’s error wasn’t that he spent too much, but that he didn’t spend nearly enough.”

Through war spending, in other words, the Keynesian recipe got the economic cake to rise again. In Depression, War, and Cold War, however, economic historian Robert Higgs documents that in fact war spending did not end the Depression, if by that term we mean not merely a depressed GDP but depressed living standards. Nevertheless, Bartlett insists, “[E]conomists concluded that an expansive monetary and fiscal policy, which had been advocated by economist John Maynard Keynes throughout the 1930s, was the key to getting out of a depression. Keynes was right…”

The problem, Bartlett adds, was that Keynes’s followers thought this policy was appropriate outside of a depression. When it was tried in the 1960s and ’70s, we got inflation. That made economists shy away from countercyclical policies—another error. Bartlett now contends that since we are in a Keynesian “liquidity trap” (in which interest rates are already so low that monetary policy alone is impotent), we need fiscal stimulus. “In the short run, the case for stimulus is overwhelming. … The trick is to front-load the stimulus as much as possible while putting in place policies that will tighten both fiscal and monetary policy next year.” Because speed is of the essence and because government spending will be hard to curtail later, he prefers stimulus through tax policy.

In 2004, Bartlett declared in National Review Online, “Keynes developed his theories in the 1930s precisely in order to save capitalism.” He said this of the same man who wrote, “I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment,” who praised state socialism for its “courage [to engage in] bold experiments,” and who found the free market obnoxious because it is based on the “money-motive.”

We might dub Bartlett a supply-side Keynesian, and he would not be the only one. In 2008, conservative economics commentator Lawrence Kudlow recalled that when he went to work for President Ronald Reagan in 1981,

One of the architects of supply-side economics, Columbia University’s Robert Mundell, [said] that during periods of crisis, sometimes you have to be a supply-sider (tax rates), sometimes a monetarist (Fed money supply), and sometimes a Keynesian (federal deficits). I’ve never forgotten that advice. Mundell was saying: Choose the best policies as put forth by the great economic philosophers without being too rigid.

Perhaps the first supply-side Keynesian was Lord Keynes himself. According to Bartlett, Keynes wrote, “Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget.”

This shouldn’t surprise us too much. Keynes, according to New York University economist Mario Rizzo, lost confidence in countercyclical government spending in the late 1930s. The Keynesians have yet to catch up with their master.

That supply-siders can also be Keynesians may seem paradoxical: in the 1970s and ’80s, supply-side economics arose in rebellion against Keynesianism. Keynesians tended to be concerned with demand and its effect on employment. If the economy was in recession, the solution was to increase demand through government spending. This, it was said, would stimulate investment and employment.

The supply-siders responded by invoking the great classical economist J.B. Say, who argued in effect that if the supply side of the economy is thriving, demand takes care of itself. This is because supply is demand. When someone produces a good in a modern economy, it’s because he wants to trade it—through the medium of money—for something else. Ultimately goods trade for goods. The more that’s produced, the more that’s demanded. Say’s critics who render his law as “supply creates its own demand” set up a straw man. As James Gwartney writes in The Concise Encyclopedia of Economics, “Virtually all economists accept this proposition and therefore are ‘supply siders.’”

A second, more prominent aspect of supply-side economics is the belief that high marginal tax rates reduce the incentive to work and encourage tax avoidance. The flipside is that cutting marginal rates produces higher revenues for the government (as Keynes seems to have believed, too).

Despite their differences, conservative Keynesians and supply-siders can resemble each other. In a recession a conservative Keynesian could favor a cut in marginal tax rates to stimulate demand and, thereby, investment, while a supply-sider would favor a cut in marginal tax rates to stimulate investment and thereby demand. The policies look the same from the outside.

Another overlap between Keynesians and supply-siders is their nonchalance about deficit spending and the inflation it prompts. This attitude is revealed in the supply-siders’ gusto for tax cuts even without offsetting spending cuts. Supply-siders tout the revenue-enhancing effects of slashing marginal tax rates, but the extent of those effects is disputed. As the monetarist Milton Friedman used to point out, the level of government spending, not taxation alone, is the better measure of the burden of government, since one way or another the money is extracted from the private economy.

The trouble with Keynesianism is not only that its focus on macroeconomic aggregates to the neglect of microeconomic human action on the ground “conceal[s] the most fundamental mechanisms of change,” as F.A. Hayek noted. It is also that Keynesianism sanctions politicians in doing what they wish to do already: spend the people’s money, debauch the currency, and engineer society in their own image—all in order to stay in power. All too often, the Right’s economic program has amounted, in practice, to a variation on Keynesian themes—stimulating demand through tax cuts without spending cuts or military spending rather than the public works favored by the Left. The result, either way, is bigger government, ballooning deficits, inflation, and recession.

It’s not true that “we’re all Keynesians now.” But enough of us are to justify concern about the future. 


Sheldon Richman is the editor of The Freeman (www.fee.org).

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