Wednesday, November 26, 2014

Keynes is becoming a better-known name again, finally

Keynes and the contra-cyclical economics associated with his policy recommendations have been getting a lot more attention lately, due to the prolonged stagnation in Japan, the slow recovery in the US and the ongoing depression in the eurozone.

Bloomberg Businessweek recently featured a cover story by Peter Coy, John Maynard Keynes Is the Economist the World Needs Now 10/30/2014:

... even in the past tense, the British economist, investor, and civil servant John Maynard Keynes has more to teach us about how to save the global economy than an army of modern Ph.D.s equipped with models of dynamic stochastic general equilibrium. The symptoms of the Great Depression that he correctly diagnosed are back, though fortunately on a smaller scale: chronic unemployment, deflation, currency wars, and beggar-thy-neighbor economic policies.

An essential and enduring insight of Keynes is that what works for a single family in hard times will not work for the global economy. One family whose breadwinner loses a job can and should cut back on spending to make ends meet. But everyone can’t do it at once when there’s generalized weakness because one person’s spending is another’s income. The more people cut back spending to increase their savings, the more the people they used to pay are forced to cut back their own spending, and so on in a downward spiral known as the Paradox of Thrift. Income shrinks so fast that savings fall instead of rise. The result: mass unemployment.[my emphasis]

Coy also describes the need that more policymakers and advisers are seeing for alternatives to neoliberal orthodoxy, aka, the Washington Consensus:

The big question is whether today’s international financial architecture is up to the challenge of restoring balance to global trade and investment. The IMF, to its credit, has pivoted away from the austere prescriptions of the “Washington Consensus” that it championed through the 1990s and toward a more Keynesian perspective. “His thinking is more relevant at the current juncture than it had been in previous troughs of the global economy,” says Gian Maria Milesi-Ferretti, deputy director of the IMF’s research department.

But the IMF lacks the authority that Keynes’s stillborn international clearing union would have had, and it’s perceived in some quarters to be beholden to U.S. interests. Brazil, China, India, Russia, and South Africa are trying to set up an alternative. Germany isn’t heeding the IMF much either as it presses France and Italy to take the same austerity medicine as Greece, Ireland, Portugal, and Spain. “Flash-in-the-pan, short-term stimulus programs” aren’t the way to boost growth, German Economics Minister Sigmar Gabriel said on Oct. 20 in advance of a joint ministerial meeting in Berlin. At loggerheads, the Germans and French punted a joint proposal to Dec. 1. Eswar Prasad, a Cornell University economist and author of The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance, writes in an e-mail that Keynes’s proposed system “requires good domestic policies and a heavy dose of international cooperation,” both of which are in short supply. [my emphasis]
Coy doesn't mention that Sigmar "Sigi Pop" Gabriel is a Social Democratic Minister in Angela Merkel's Grand Coalition government who is willing backing Merkel's Herber Hoover/Heinrich Brüning economic policies for the eurozone.

Peter Temin and David Vines also write about Keynes in Why Keynes is important today VoxEU 11/14/2014. They discuss how a theory called Ricardian Equivalence came to be a dominant idea among those Paul Krugman calls the Very Serious People:

Ricardian Equivalence is a theory that concludes that any expansion of public spending will be offset by an equal and opposite decline in private spending. The theory is based on a few important assumptions. It assumes forward-looking consumers who adjust their current spending in anticipation of future taxes to pay for the spending. Under these conditions, any increase in current spending leads consumers to anticipate a rise in future taxes and decrease their current spending to save for this.

This theory dominates current macroeconomic discussion. It fits into the form of current macroeconomics that assumes not just forward-looking consumers, but flexible prices as well. And if a Keynesian suggests fiscal policy in current conditions, a modern economist is likely to invoke Ricardian Equivalence.
They also link to a column by Krugman on the concept, A Note on the Ricardian Equivalence Argument Against the Stimulus (Slightly Wonkish) 12/26/2014, in which he explains:

Ricardian equivalence says that what determines consumption is the lifetime present value of after-tax income, and hence that, say, a temporary tax cut won’t stimulate spending, because people will figure that whatever they gain now will be offset by higher taxes later. It is a dubious doctrine even done right; many people are liquidity constrained, and very few people have the knowledge or inclination to estimate the impact of current government budgets on their lifetime tax liability.

But even if you assume that the doctrine is right, it does NOT imply that government spending on, say, infrastructure will be met by offsetting declines in private spending.

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