Thursday, January 8, 2009

We Are All Keynesians Again

The Lehmann Letter ©

John Maynard Keynes (rhymes with brains) wrote The General Theory Of Employment, Interest And Money in 1936. He noted aggregate demand’s collapse during The Great Depression and advocated public-sector spending to compensate for the paucity of private-sector expenditures. If households and businesses wouldn’t borrow and spend, government would have to fill the vacuum. That was the only way, said Lord Keynes, to restore full production and full employment.

Government public-works spending alleviated unemployment during the New Deal, but WWII restored full employment. Massive war time borrowing and spending lifted production to the point everyone could find work. Keynes’s analysis had been correct.

But Keynes’s prescription no longer seemed relevant in the general prosperity following WWII. Then President Kennedy resurrected it, with a twist, when he took office in 1961. JFK recommended a tax cut rather than a spending increase in order to spur economic growth. The logic was simple: A tax cut, without a government-spending reduction, would boost household disposable income and consumption, thereby augmenting aggregate demand. It didn’t matter if consumption rose or government spending rose, as long as total spending grew.

Republicans were skeptical, and Congress delayed the tax cut’s passage. After JFK’s assassination, however, the measure sailed through under President Johnson’s direction. The economy enjoyed robust growth, earnings and employment through the mid and late 1960s.

When recession struck in 1970, President Nixon broke free from Republican qualms. He embraced a tax cut without an offsetting reduction in federal expenditures. The federal deficit would rise, but revert to surplus once prosperity returned. Congress agreed. President Nixon summarized matters succinctly when he said, “We are all Keynesians now.” (Remember: Keynesian rhymes with brainsian.)

Keynesian economics, but not tax cuts, fell from favor during the Reagan years. President Reagan emphasized aggregate supply, not demand. Some wondered: How can you tell? A tax cut is a tax cut is a tax cut. It’s difficult to distinguish demand-stimulus from supply-stimulus. The motivation is less important than the outcome. Nonetheless Republicans stayed with supply-side economics and did not advocate increased federal spending to spur economic growth.

But the current recession has changed all that. Republicans recognize the need to stimulate aggregate demand. Despite warnings that we may be facing another Great Depression, that’s not likely to happen if the federal government responds swiftly. President-elect Obama’s call for massive public-works expenditures as well as tax cuts should, if enacted, forestall the kind of collapse that beset the economy from 1929 through 1932. In those earlier years the federal government stood by and let private borrowing and spending wither without an offsetting increase in federal borrowing and spending. There’s no need for that to happen this time.

We are all Keynesians once again.

© 2009 Michael B. Lehmann

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