Saturday, October 29, 2011

Four Reasons Keynesians Keep Getting It Wrong

This is really remarkable, a very mainstream economist who looks like he could be writing for EPJ. How mainstream? Alan Meltzer is a professor of public policy at the Tepper School, Carnegie Mellon University and a visiting scholar at Stanford University's Hoover Institution.

In 2007, Meltzer was honored by President George W. Bush at an awards dinner.

Here is part of what he wrote in WSJ on Friday in a commentary titled, Four Reasons Keynesians Keep Getting It Wrong. Meltzer doesn't understand the recovery that is coming, but outside of that he is pretty solid. He even gets the excess reserves problem! (My bold):
Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery. Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%...

Why is the economic response to increased government spending so different from the response predicted by Keynesian models? What is missing from the models that makes their forecasts so inaccurate? Those should be the questions asked by both proponents and opponents of more government spending. Allow me to suggest four major omissions from Keynesian models:

First, big increases in spending and government deficits raise the prospect of future tax increases. Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will
reach that conclusion by continuing to demand permanent tax increases. His demands are a deterrent for those who do most of the saving and investing.Concern over future tax rates is one of the main reasons for heightened uncertainty and reduced confidence. Potential investors hold cash and wait.

Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment. Keynesian theory argues that each dollar of government spending has a larger effect on output than a dollar of tax reduction. But in reality the reverse has proven true. Permanent tax reduction generates more expansion than increased government spending of the same dollars. I believe that the resulting difference in productivity is a main reason for the difference in results...

Third, Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy...

Fourth, U.S. fiscal and monetary policies are mainly directed at getting a near-term result...

The Federal Reserve, too, has long been overly concerned about the next quarter, never more than in the current downturn. Fears of a double-dip recession, fanned by Wall Street, have led to continued easing and seemingly endless near-zero interest rates. Here, too, uncertainty abounds. When will the Fed tell us how and when it is
going to sell more than $1 trillion of mortgage-related securities? Will Fannie Mae, for example, have to buy them to hold down mortgage interest rates?

By now even the Fed should understand that we do not have a liquidity shortage. It has done more than enough by adding excess reserves beyond any reasonable amount. Instead of more short-term tinkering, it's time for a coherent program to start gradually reducing excess reserves.
>Again,the only major thing Meltzer is missing is the fact that because of Ben Bernanke money printing, the economy is about to experience a manipulated boom. The Keyenesians don't see this (and I guess Meltzer is missing this also). But, Meltzer correctly points out that many of the Keynesians, such as Paul Krugman, are calling for even more government spending, even though that did nothing to turn the economy around (The manipulated turn started when money started moving out of excess reserves).

Bottom line: The Keynesian model is one gigantic failure and we have one mainstream economist who recognizes that fact.


  1. Robert,

    This guy has an interesting statistical correlation but the data is a tad old. Do his observations gell with recent spending patterns?

    See here.

  2. Keynesians don't know about the Ricardo Effect, either. Government spending stimulates sales of consumer goods. That makes labor in consumer goods industries cheaper and use more labor instead of buying labor-saving capital equipment. That is basic econ 101.