When John Maynard Keynes came to prominence, the laissez faire free market economic approach of Adam Smith, what we know as capitalism, was, for the first time since it’s introduction in 1776, finding itself incapable of righting the Great Depression. Until that time, all classical economic thought was of the opinion that, no matter how bad the short term situation was, the capitalist economy could quickly right itself. But, as the Crash of 1929 dragged into 1932 with no recovery in sight, Franklin Roosevelt was looking for a new paradigm to change the languishing US economy. Into the picture rode Keynes.
Keynes believed that, in times of relative prosperity and full employment, the hands-off self-regulating form of capitalism would perform well. But he also believed that, once a recession or depression hit the economy, the classical model of capitalism was not inclined to return to full production without stimulus from the Government. Stimulus could take the form of monetary stimulus or major public works. At this time it would be necessary for the government to use deficit spending, by which large amounts of money could be injected into the economy to restart it.
Roosevelt used public works as his method of stimulus. Keynes believed that any kind of works would help, simply because injecting money into into building projects would create a multiplier effect. If, for instance $100 million was spent building a dam, then that money would be spent by the builders to buy food and necessities . In turn, the businesses that provided the food would turn around and buy their own necessities, and so on. So the $100 million would trickle down through the economy and produce $400 million in economic stimulus.
Whether Roosevelt’s plan actually worked is a subject for much debate. By the end of the decade, the economy was still languishing. Then along came WWII, and the government had to invest nearly half of the GDP in the war effort, which not only sparked a huge demand for production of war material, but also necessitated that other factories pick up domestic production to fill in for the factories dedicated to the war effort. In a sense, this was stimulus as well. But what really changed was the mood of the people, who were now supremely motivated to get back to work.
As Obama rolled into office in 2009, the economy of the US in specific and the world in general was in a state of malaise not seen since the Great Depression. It is not hard to understand, then, that Obama planned to use the same Keynesian approach to our current crisis that FDR had used. However, he realized that FDR’s program had been marginally successful, if at all, and that the recovery had taken almost a decade. Obama promised that he would have us out of the recession within his first term. To accomplish this, he was not going to make the same mistake that FDR made. As one of his advisers said on the eve of the inauguration, “FDR’s mistake was that he didn’t spend enough money. We will spend twice as much.”
But, the mistake that the Obama administration did make was that they didn’t pay close attention to what Keynes said about stimulus. To quote from Mark Skousen in The Big Three in Economics:
Keynes Favors Public Works over Monetary Inflation
Keynes felt that tinkering with fiscal policy (changes in spending and
taxes) was more effective than monetary policy (changes in the money
supply and interest rates). He had lost faith in monetary policy and
the Federal Reserve in the 1930s, when interest rates were so low that
reducing them wouldn’t have made much difference (see Figure 5.2).
Inducing the Federal Reserve to expand the money supply would not
be very effective either, because banks refused to lend excess reserves
anyway. Keynes called this a “liquidity trap.” The new money would just
pile up unspent and uninvested because of “liquidity preference,” the
desire to hold cash during a severe depression (1973a , 207).
(M.E. Sharpe, 2007, 160)
Whereas FDR ramped up spending in the form of public works project, Obama encouraged the FED to expand the money supply through quantitative easing and to lower interest rates. But, as Keynes pointed out, this won’t work. Expanding the money supply won’t do any good because the banks who are supposed to distribute the money in the form of loans would only raise loan requirements and refuse to lend money in an effort to stay solvent. Also, lowering interest rates does not have much effect when the rates were already historically low. So, the very thing the stimulus is designed to do–create liquidity and get the economy moving–cannot be done with monetary changes.
Obama’s hope of quick recovery was to double down on FDR. Even though he did manage to short the government coffers as never before, he forgot to read Keynes’ playbook. When he should have tried to kick the winning 60-yard field goal, already a long shot, he decided on a quarterback sneak instead. No shot.
What is Obama’s plan, now that the quarterback sneak didn’t work? I believe he intends to try another one. This time he will force people to save less by giving them higher taxes on which to spend their money–an artificial way to stimulate the economy through spending. Of course he talks about stimulating the economy by creating green industry. But that is a long and illusive goal. Even Keynes would scream at him to think about the short term, because “in the long run, we’re all dead.” In the short term, he could at least try removing the roadblocks to domestic energy production, a stimulus plan even better than the WPA, because we won’t have to pay for it with more deficits.
Perhaps Obama has really done this country, and the world, a service. Perhaps he has help us get over our love affair with John Maynard Keynes and the archaic notions of deficit spending. Unfortunately, by leading us to the brink of total collapse, he has forced us into certain austerity measures. But even that may be a blessing. Reducing the Welfare State will force more people to have to work for their survival. If we could then remove the press of regulations and unleash the private sector’s economic engine, we just might find that good old classical capitalism has a few answers after all.
- Hayek: Keynes was a Quack… (economicpolicyjournal.com)
- Keynesianism & Eugenics (genomega1.wordpress.com)
- BBC’s Hopeless Attempt to Elevate Keynes (thedailybell.com)