Why keynes was right

The textbooks teach that policymakers have two tools at their disposal to counteract a downturn. One is monetary policy, which can lower interest rates to encourage consumers and businesses to borrow more and use the money for spending on consumer durables, housing, factories or equipment. The second tool is fiscal policy, which can temporarily increase government spending or cut taxes — again with the goal of raising consumption or investment.

Economists generally prefer that fighting business cycles be left to monetary policymakers because they do not trust the president and Congress to get it right. One fear is that the glacial political process will fiddle and haggle until well after the recession has passed, thus destabilizing the economy and contributing to higher inflation.

Another fear is that in an election year, the president and Congress will try to push the economy beyond its capacity, again triggering inflation with little economic benefit. But neither of these arguments is grounded in any fundamental insight; they are just based on a presumption about the political system. But this time, the presumption about the political system appears to be wrong. The economy appears to be slipping into a potentially serious downturn.

The Federal Reserve has cut rates by 1. Fortunately, Congress and the president appear set to fill in some of the gap before It is likely that in May, June and July the U. Australia can take comfort — Keynesian policies have been broadly vindicated. In contrast, the US and Australia have each experienced real economic advances. The debate has more recently been marked by revelations of shoddy scholarship by once-leading economic lights like Harvard professors Ken Rogoff and Carmen Reinhart , who famously erred in characterising the historical relationship between rising debt and falling growth, inadvertently omitting strong performers like Canada, New Zealand and Australia from their calculations.

More important, however, than any of their spreadsheet errors was their lack of theoretical insight, as they failed to recognise that the relationship is best seen as one of reverse causality: rising debt does not cause falling growth, so much as falling growth causes rising debt.

In the end, perhaps the best thing to do is simply to look at the history of the US economy, which has since been in surplus only for nine years — and in deficit for 54 years — over a period of fantastic growth. The economic costs of deficits would seem, on reflection, to be overrated. The Federal deficit in World War 2 was massive—much bigger than any time during the Great Depression.

And we built up a huge Federal debt load. Our current debt and deficit situation scares the bejeezus out of me. We absolutely have to get our long-term budget problems under control, and doing so will involve both cutting spending and raising taxes. If we don't do that, we really will collapse, as Niall Ferguson et al have long been arguing. Incurring debt to build things that help all Americans, from unemployed folks to business leaders to children, is a trade-off I'm willing to make.

Especially if the jobs created by this "stimulus" spending help alleviate our massive unemployment and inequality problems. And, by the way, I don't think this "stimulus" necessarily needs to come from just the government. Our corporations are as profitable now as they have ever been. So I'd like to see a lot of them voluntarily decide to invest more and pay their low-wage employees more and hire more employees.

They can afford it, and "cash flow" isn't the sole objective or reward of running a business. For you. World globe An icon of the world globe, indicating different international options. Get the Insider App. Click here to learn more. A leading-edge research firm focused on digital transformation. Good Subscriber Account active since Shortcuts. Account icon An icon in the shape of a person's head and shoulders.

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