Is There Really a "Keynesian Case"?

By William L. Anderson

Despair overtakes Paul Krugman. It is so bad that he wants "to stick a pencil" in his eye, which not only would hurt a lot, but also just might blind him and make him even more despairing.


Why this deep, dark depression? It seems that pundits do not "understand" the so-called Keynesian Case, that special set of circumstances which, according to all True Believing Keynesians, justifies government spending sprees, printing of money, and borrowing into oblivion. As Krugman writes:

I’ll be frank: the discussion of fiscal stimulus this past year and a half has filled me with despair over the state of the economics profession. If you believe stimulus is a bad idea, fine; but surely the least one could have expected is that opponents would listen, even a bit, to what proponents were saying. In particular, the case for stimulus has always been highly conditional. Fiscal stimulus is what you do only if two conditions are satisfied: high unemployment, so that the proximate risk is deflation, not inflation; and monetary policy constrained by the zero lower bound.

That doesn’t sound like a hard point to grasp. Yet again and again, critics point to examples of increased government spending under conditions nothing like that, and claim that these examples somehow prove something.

In other words, Krugman is demanding that we meet him on what he considers to be HIS ground. He then takes issue with Tyler Cowen's criticism of "fiscal stimulus" when Cowen uses the experience of Germany in the early 1990s:

1. This was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand — it was trying to rebuild East German infrastructure to raise the region’s productivity.

2. The West German economy was not suffering from high unemployment — on the contrary, it was running hot, and the Bundesbank feared inflation.

3. The zero lower bound was not a concern. In fact, the Bundesbank was in the process of raising rates to head off inflation risks — the discount rate went from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this rate rise was a deliberate effort to choke off the additional demand created by spending on East Germany, to such an extent that the German mix of deficit spending and tight money is widely blamed for the European exchange rate crises of 1992-1993.

In short, it’s hard to think of a case less suited to tell us anything at all about fiscal stimulus under the conditions we now face.

While Krugman never is going to admit that one can legitimately criticize his positions, nonetheless I do believe it is instructive to look into this "special Keynesian Case," better known as the "Liquidity Trap." Because I include Krugman's explanation above about this particular set of circumstances, and even though he does not identify it as a "Liquidity Trap," that is what he is describing.

Read the rest here.