EDITOR’S NOTE: This is the sixth column trying to answer a reader’s question: What is a liberal and what is a conservative? Links to the the first five columns are below.
There’s a YouTube video of economist Milton Friedman talking about John Maynard Keynes and all that is wrong with Keynesian economics.
He was clearly not a fan. Still, he recognized reality.
When times get tough, everyone loves Keynes. “We are all Keynesians now,” Friedman coined, attributing it to Richard Nixon and his embrace Keynesian policies in 1965.
Keynes was a British economist who proposed a radical change to how governments manage the economy. His greatest work, “The General Theory of Employment, Interest and Money,” was published in 1936.
The world was in the middle of the Great Depression and things weren’t improving. Like a family does when times get tough, governments were cutting spending and conserving resources, trying to weather the storm.
That only made things worse, Keynes argued. He said when times get bad, that’s the time for governments to spend money, even if they have to borrow it.
He said government would likely have to spend some of that anyway in unemployment benefits, such as food stamps, and welfare checks. By spending it instead on needed infrastructure projects, you’re giving people jobs, who in turn will spend those wages, boosting the economy. As they spend, tax revenues will return to the government. He called this the multiplier effect.
It also works in reverse. When people don’t have jobs, they don’t spend, they save whatever they have because of an uncertain future. If they’re not spending, it hurts the economy, which means more businesses will lay off other workers. The cycle continues.
The economy can go in two directions, and Keynes argued that in down times there was not enough demand, the government should put more money into the economy.
He considered three ways to stimulate the economy. The first was for the central bank to lower borrowing rates to close to 0 percent and buy government bonds at a higher rate. The second was to cut taxes, and the final option was to spend.
He dismissed the first option because he feared the “liquidity trap.” That’s where people hoard money instead of spending it because they fear deflation is on the horizon.
He thought tax cuts could help an economy, but feared that some people would save the money, or pay off debts, rather than spend it. He argued that if you’re going to do tax cuts, then they should be permanent so people don’t fear it’s a one-time event, and the majority should go to people who earn the least amount of money, because they will be most likely to spend it.
He settled on the third way, government spending, as the most efficient because you didn’t have to worry about people hoarding cash. It was a direct injection into the economy.
His ideas were embraced by all the capitalist nations at the time looking for a way out. Franklin Delano Roosevelt started the greatest jobs program in U.S. history and much of our existing infrastructure today was built then, including roads, airports, bridges, and the electrical grid.
That, coupled with the buildup to World War II, pulled America out of the Great Depression.
Keynesian economics led to nearly three decades of prosperity, but it had its critics. First, it would be great in the short term, but what about the long term?
When governments put more money into the economy, two bad things happen. First, people who had been saving their money soon discover their money is worth less.
The second is inflation, and that is what led to Keynesian economics falling out of favor in the late 1970s. Inflation reached 14 percent in 1980 (due to rising oil prices and really bad monetary decisions).
For Keynesian economics to truly work, it must be a short-term program and governments need to pull back on spending when the economy is out of danger. And that is where Keynesian economics has been a complete failure.
History has shown us few politicians ever think the economy is good enough. Spending money and cutting taxes are popular with voters, so instead of paying off the debt during good times, our politicians continue to spend money and cut taxes. Our national debt was $33.7 billion in 1936 when Keynes’ book was published. Now, 82 years later, it’s $20.6 trillion, and climbing.
Both major parties have shown they will stimulate the economy even when times aren’t really bad. Democrats want to follow the traditional Keynesian model of increasing spending while Republicans prefer cutting taxes. Both have shown they are willing to borrow huge amounts of money to do it, rather than make the hard choices to cut spending.
We are all Keynesians still.
Next week I’ll focus on a Keynes critic, another economist who has had a major influence on us today: Friedrich A. Hayek.
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