Thursday, December 4, 2008

The Great Keynesian Debate

The current recession looks increasingly severe. As people talk more of depression economics rather than just a cyclical downturn, there is increased interest in Keynesian economics and whether this offers a solution

Video On Keynesian Economics

Keynesian economics has become important because it looks like Monetary policy is insufficient to return the economy to equilibrium. See: Impotence of monetary policy

Criticisms of Keynesianism (taken from youtube comments)

> When government spends more ppl have less to spend

Maybe in a boom, but in a recession resources are idle so the government is forcing resources to be used that previously wouldn't. The economic uncertainty means people are looking to save in bonds. Therefore, government borrowing is not curtailing private sector investment. See also: Crowding out

>If government borrows they can only borrow so much.

This is true to some extent, and it is a shame governments weren't more prudent in the boom years. But, it is quite possible for public sector debt in the UK to rise from 40% of GDP to 50 or even 60% of GDP. The good news is with low interest rates, the cost of financing debt is low.

> As well, if you accept that theory all it means is that the economy will go back into a recession when the government finally needs to pay off its debts.

No, if you increase tax rates during economic growth, you may slow down the rate of growth and avoid inflation, but, it doesn't have to cause another recession. For example, after big tax cuts in 2001, the US government should have reversed some of these tax cuts around 2003-05. This would have lessened the boom and reduced the deficit giving more room for manoeuvre in this recession. Fiscal policy is a two way policy. It's not just about boosting demand in a recession.

> 2) It will cause monetary inflation

Where's the inflation? People talk of inflation as being a problem, but, inflationary pressures are collapsing. US consumer prices fell last month. The real concern is deflation. Deflation can devastate the economy. This is why Japan failed to recover in the 90s and 00s - it refused to create inflationary expectations. In a great depression, you want to create a moderate inflation rate! This is why governments target inflation of 2% and not 0% or -2%. If you boost aggregate demand too much as the economy recovers then you can cause too much inflation. But, nearly all economists would agree it is far more dangerous to have a little deflation than a little inflation.

Vintage Keynesian Propaganda

- The best bit is probably the cow mooing to prove he is a cow. Anyway, an interesting angle on economics!

Two Different Economic Perspectives on Keynesian Economics

Paul Krugman - Deficits and Spending
- One of the most articulate supporters of a Keynesian approach. Krugman argues government borrowing is necessary in present situation.

See also: Depression economics returns

David Smith - Only Spending Cuts will get us out of this black hole. David Smith argues that the increased government borrowing is the biggest problem. Many other economists share his opinion.

What's your opinion? - Do you support the Keynesian approach? or do you think expansionary fiscal policy will just make things worse?



Anonymous said...

Wheres the inflation? I remember when I was young a movie ticket was 5 dollars. By the time I got out of high school it was 10. So it drops to 8 and there is no inflation?!

The long term trend is obviously inflationary, pick up any consumer catalogue from 20 years ago and you will see a dramatic increase in the price level. Heck, ask one of your older relatives about prices in the past, and for some mysterious reason even though production and transport costs have fallen dramatically the price level for all goods is higher.

True we are experiencing deflation at the moment, but that happens after every bubble bursts. When the inflationary bubble bursted in 1929 there was temperary deflation, followed by inflation so hardcore the government literally confiscated all the private gold it could find.

There was deflation (or rapid decreases in inflation rate) after the bubble of the 70's broke, after the dot com bubble, and the new real estate bubble.

Yet the long term trend is clearly inflationary, all you have to to do is ask an older relative or look at an old catalogue.

Robert Kaplan said...

Here we now are in mid-2015, seven and a half years later, and still frightened about non-existent inflation? Maybe it's coming (sometime).