John Maynard Keynes was a very smart man. Bertrand Russell, who was no dummy himself, said that whenever he argued with Keynes, he felt he was taking his life in his hands and generally emerged feeling like a fool.
John Maynard Keynes
Prior to Keynes, the accepted thinking among economists was that the working of the free market always brings things into balance, and the best cure for recessions is to leave things alone and allow the balance to restore itself. What Keynes noticed that his predecessors didn’t was that the economy could come into balance at a high level of unemployment and low level of economic activity, and stay there for a very long time.
A economic crash creates a domino effect. When people lose their jobs, they stop spending money, which means that business is bad, which means that more people lose their jobs. Bank failures beget bankruptcies, and bankruptcies beget bank failures. Recovery can be slow, because businesses aren’t going to hire people unless there are potential customers.
Keynes thought governments could help speed up recovery by putting people to work on public projects, by cutting taxes, by running temporary budget deficits to put money into circulation, and by trying to push down interest rates so people could more easily borrow to buy things and businesses could more easily borrow to expand. He thought government to stop the cascading effect of depression by creating social safety nets, such as unemployment insurance and deposit insurance.
The second part of his philosophy was that when times were good, governments should pay down their debt and try to keep inflation under control.
His ideas came to be accepted wisdom during the 30 or so years following his death in 1946, and recessions during that period were milder than in the pre-Keynesian era. However, the first part of his philosophy was more popular than the second part. The Clinton administration raised taxes and reduced civilian spending when times were good, but this was the exception rather than the rule.
A lot of smart people think the sick U.S. economy needs a stronger dose of Keynesianism than President Obama or the Democrats have been willing to propose. I think the Keynesian medicine may not have as strong an effect as in the past.
We are coming down from an over-stimulated economy. Under President Bush, the government cut taxes, especially in the upper brackets, while increasing government spending. Government debt mushroomed, and consumer debt and the U.S. trade deficit continued their long-term upward trend. This is something that could not go on forever, and so it stopped. This limits the effectiveness of any stimulus. People who get any extra money over and above what they need are going to use it to pay down debt.
We live in a global economy. If we import increasing amounts of goods from foreign countries, any increased consumer spending is as likely to benefit foreign manufacturers as our own.
So it looks as if we have two bad alternatives. One is to do nothing and let the economic stagnate. The other is to try things that may have little effect.
I think we need to maintain the social safety net. I don’t think we can cut off unemployment compensation for the long-term unemployed when there are five job-seekers for every job opening. I think the federal government has to provide state aid to keep local government functioning. You don’t foster a vibrant economy by laying off school teachers, closing public libraries and raising state college tuition. Budget problems have forced at least 38 of Michigan’s 83 counties, and an unknown number in other states, to give up paved roads.
Beyond that, I think we as a nation need to invest in things we need for our future – in infrastructure, education and scientific research. And what better time to do it than now, when so many people are out of work and when interest rates are at near-record lows?