Human nature vs. Keynesian economics

The trouble with Keynesian economics is that it asks too much of human nature.

The late great British economist John Maynard Keynes said it was possible for governments to smooth out the business cycle of boom and bust by doing what Joseph and Pharaoh in the Bible did—to store up surpluses in the good years, and draw them down in the bad years.

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Human nature is just the opposite.  Human nature is to spend money when you have it, and to cut back when you don’t have it.  This is pretty much the history of U.S. government policy during the past 10 years.  During a period of economic growth, the George W. Bush administration added to the government’s debt by cutting upper-bracket taxes, by starting two major wars and by adding a new mandate to Medicare.   Barack Obama took office in the middle of a recession with a government already deeply in debt.   Whatever you think of the President’s decisions and priorities (and I think they are mostly wrong), he  is in a situation where he has few good options.

John Maynard Keynes was not an advocate of big spending or high taxes.  He said that, in times of recession, the government should either increase spending or cut taxes—either one would do.   President John F. Kennedy, for example, promoted a temporary business investment tax credit in order to counter a business downturn during his administration.  But the best way to fight recession, according to Keynes, would be programs or tax cuts that helped low-income and middle-income families because those families would be most likely spend money and stimulate business activity.

But whether government increased spending or decreased taxes, the increase or decrease should be temporary, Keynes said.  As economic activity picked up, spending and taxes should revert to normal.  This is where his ideas are contrary to human nature.  As soon as you start a new government program or lower taxes, you create a constituency to keep the program and the tax break through good times as bad.

Historically the Federal Reserve System, because it is somewhat (not completely) buffered from political influence, has been able to implement Keynesian economics better than the President and Congress have.  The Fed has used its powers to influence interest rates to stimulate borrowing when times are bad, and to throttle down on credit when times are good.  As a former chairman once said, the Fed’s job is to take away the punch bowl when the party starts getting good.  Unfortunately, under the leadership of Alan Greenspan, the Fed’s policy was just the opposite.  During the stock market and housing bubbles, the Fed spiked the punch bowl instead of taking it away.

Another way to protect Keynesian policy from human nature is to put policies in place that automatically respond to changes in the economy.  One example is unemployment compensation.  In good times, workers and employers normally pay more into the compensation fund than they take out; in bad times, the fund pays out more than it takes in.  It would be possible to increase the effect by having payroll taxes automatically go up when a state’s unemployment rate goes down, or to increase the period of eligibility for unemployment when the unemployment rate goes up.

I think the ideas of Keynes were good as far as they went.  I think the United States is in a situation in which a Keynesian stimulus is not enough.  The U.S. government is already deeply in debt, and we Americans individually are deeply in debt.  We need to rebuild our productive capacity, not just jump-start the economy, and this requires more than temporary measures.  That in many ways is a more difficult challenge than faced President Franklin Roosevelt during the Great Depression.

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