Monday, February 9, 2009

Conservative Keynesian Myth

There is a myth going around. Largely it is repeated in Conservative circles, but many political pundits (George Will and Newt Gingrich chief among them) like repeating it. They repeat over and over that "Keynesian economics has never worked." Yet immediately they turn right around and thoroughly disprove themselves.

The most openly Keynesian action by our government was the New Deal of FDR in the 1930s. Conservatives claim that Keynesian policy was an absolute failure because we didn't fully exit the Depression until World War II. They ignore two major flaws in this thinking.

The first problem is that Keynesian policy wasn't used throughout the Depression. From 1933 into 1937 FDR took the "kitchen sink" approach. He would try something, see how it worked and either continue it or move on to something else. The WPA and many other programs were started and got people back to work. For these four years, GDP grew an average of 10% per year, unemployment fell from 25% to a minimum of 12% in June of 1937 (using the same calculation for unemployment today that they used then, we are currently between 14 and 16%), and created an average 9% annual increase in average incomes.

Throughout this whole period FDR and his Treasury Secretary, Henry Morgenthau Jr., were constantly worried about the expanding deficit. By 1937, things seemed to be looking relatively better. GDP had grown from $56.4 billion to $91.9 (current dollars adjusted for inflation). Unemployment, as I said above, had fallen by nearly 50%. FDR let his inner deficit hawk take control and cut spending by over about two billion dollars (adjusted for inflation). When this happened, GDP stumbled and fell more than 3% and unemployment jumped to 19%.

Then we get to the second half of the Conservative myth wherein they contradict themselves. Every Conservative economist claims that the Great Depression disproves Keynesian economics because we didn't pull out of the Depression fully until the war effort ramped up. But if you look at that, it only proves Keynes correct. The war effort didn't have tax cuts, it didn't have a balanced budget (just the opposite, spending 140%+ of GDP). No monetary policy brought us out of the Depression during WWII. It was direct government spending unlike anything we had seen before or have seen since.

Other policies can help with recessions. Monetary policy has worked in the past, as recently as 2001. Tax cuts sometimes help, but rarely in isolation (see 2008 for an example of a tax cut failing in isolation). But these options aren't available to us and don't work in a demand death spiral like we are in now. Monetary policy is used up, we are at 0% interest. Tax rebates have already failed once and the smaller one being proposed now won't work any better. Tax incentives for purchases can't work if people can't purchase. The only thing left is for the US government to directly stimulate demand by direct spending. Other things like the middle class tax cut may help on the short term while government spending ramps up, but without the larger government projects, that short term stimulus will be wasted just as quickly as last year's stimulus checks.

UPDATE: Rachel Maddow discussed this as well. Here is an article with other good charts that reflect my points.