What Keynesian Actions Should the Government Take?

Since I agree with Professor Luigi Zingales's points that (i) the economic profession has not reached a consensus on Keynesian positions; (ii) there exists no consensus among economists that the causes of the current crisis are Keynesian, it is not possible for me to rebut them. And I would quarrel with his only concession as well. He claims that "Keynesianism has conquered the hearts and minds of politicians and ordinary people alike." That is definitely *not* true. The entire Republican House and Senate caucuses and their tame intellectuals would be Keynesians right now how John McCain won the presidential election and were McCain economic advisors Mark Zandi, Doug Holtz-Eakin, and Kevin "Dow 36000" Hassett now maneuvering a tax cut-heavy stimulus bill through congress. But McCain did not win. And so Washington's Republican legislators and their think-tank poodles are as anti-Keynesian right now as the day is long. Only the Republican governors--who have to, you know, actually govern--have any Keynesian tinge.

But there is one issue where I differ with Professor Zingales, and one point I wish to defend. I believe--and he does not--that we should follow Keynesian prescriptions as one part of our program for dealing with the crisis. Let me explain:

What is the crisis? The crisis comes in six stages:

1. American mortgage originators lose $2 trillion due to their irrational exuberance investing in mortgages.
2. American mortgage securitizers who are supposed to follow an originate-and-distribute model in order to lay off the risk associated with mortgage lending onto the broad pool of savers in the global economy originate but do not distribute.
3. As a result, a large share of the $2 trillion in losses falls onto and must be eaten by Wall Street's largest institutions.
4. In response to these losses, trust in financial intermediaries and thus the risk tolerance of the private sector collapses--with $2 trillion in mortgage losses inducing a stampede away from risky assets that ultimately lowers the global value of financial assets by $30 trillion and renders nearly all if not all major financial institutions insolvent (at least temporarily insolvent).
5. Businesses that ought to be expanding thus find that they cannot obtain financing on terms that make expansion profitable--while businesses that ought to be contracting still contract.
6. Thus employment collapses.

Luigi Zingales says that having the government spend more money and raise less in taxes won't deal with 1-5--that in order to fix the banking system *we need to fix the banking system.* He is 100% correct: Keynesian policies won't deal with 1-5, and we desperately do need to deal with 1-5.

But we can limit the damage that 1-5 do to the rest of the economy by attempting to head off (6). There is no reason why we cannot put the jobless to work doing useful and productive things while we sort out the banks. There is no reason why millions in America--tens of millions around the globe--need to be without work and income over the next two years. The problem creating (6) is that the banks cannot and will not lend money to businesses that ought to be expanding in order to put more people to work. But everyone is incredibly eager to lend money to the U.S. government. So let people do so--let the U.S. government soak up the bank lending that is not being made to companies, and use that purchasing power to put people to work.

That is Keynesianism. That is what we should be doing right now. That is what everybody should be agreeing right now that we should be doing.

Comments

[atlasman:]

A few comments:

1. What happens when people are no longer "eager" to lend to the USG? I would argue that the crash that will follow will be much more painful than if we were more prudent today.

2. I am certainly not a McCain supporter, but I promise you his Keynesian spending (assuming a completely different congress makeup) would be a whole lot different and in my opinion far more effective than the Pelosi/Obama's version of Keynesian spending.

3. Lastly, if you go all in with an inefficient solution to problem 6, there really is nothing left to solve problem 5 especially considering the fact that there are other moves coming from DC (think carbon tax as just one example) that will further harm this problem.

Mar 09 07:53 AM

[LouieK:]

How do you add $400 million to the space shuttle program and thereby sop up the unemployment in retail now? Such spending employs engineers and technicians over a period of time (say, 10 years), but does nothing for the unemployed now. This is the problem with Obama's spending plans in the stimulus bill recently passed. That bill was, it seems to me, more designed to pay off constituents who helped him get re-elected than designed to stimulate the economy in a Keynesian strategy. If you don't understand that point, then maybe you are the "poodle."

Mar 09 08:48 AM

[LouieK:]

By the way, a tax-cut would be a Keynesian stimulus too. But it would be a supply side stimulus.

Mar 09 08:52 AM

[EEB:]

I agree with the author's conclusion that putting people back to work now would be a good idea. I also agree that the Obama administration's stimulus package was not well-designed.

However, we could some people back in such a way that would help the housing market and the banks. There are thousands upon thousands of dilapidated housing units around the country and thousands upon thousands of housing units in ill-conceived subdivisions. The government could put former construction workers back to work demolishing sub-standard housing. The government could buy out the few occupants of ill-conceived, half-finished subdivisions and fence them off or demolish them.

This type of program is needed in places like Cleveland and in places like California. Such a program would put people back to work now, reduce supply in the housing market, improve many neighborhoods by getting rid of abandoned homes, etc.

Mar 09 10:12 AM

[George Fiala:]

I heard Joseph Stiglitz make an interesting comment the other night at a panel in NYC. He said that if the government was worried about there being enough credit in the economy, and upset that banks aren't using the money they are being given to distribute as loans, then why does the government have this intermediary charade. Instead, they should just set up a government bank, fund it with $700 billion, using a conservative 10 x leverage that would put $7 billion into the system.

Kind of what Brad is saying I think.

My thought is that the Federal government should open up job centers in many cities where people could actually go and apply for work doing any old useful thing. Make it easy for the average unemployed person to get work to pay bills. No hoops, just work.

But of course I am not a member of the National Association of Manufacturers....

Mar 09 11:07 AM

[pacman1947:]

In Einstein's book, "The World As I See It," (written between 1924 and 1932) he comes to the same conclusion, adding only that the jobs that are created must pay a living wage so that an honest man's labor will result in his being able to raise and support his family. He believed that a rising tide raises all ships, which is a simple explanation for why good jobs that pay a living wage are the only jobs we should focus upon.

FDR's plans to rebuild America seemed to fit Einstein's hopes, so he moved here to reap the benefits of this wisdom. Of course, as a Jew, leaving Nazi Germany seemed like an excellent idea at the time.

Einstein's economic theories seemed to be as prescient as the Keynesians, only a few steps more intelligent. Many believe that Einstein had the greatest mind of the 20th century. I am one of them.

Brad, thank you for an excellent set of observations. I could not agree more. Let us hope that the current world leaders will see the evidence for a logical solution before too much damage is done.

Mar 09 11:46 AM

[Bill Jencks:]

Everybody is infatuated with Keynesianism. This is what got the US financial system in a mess in the first place. A little bit of inflation is good, a small amount of debt is OK, a small fiscal deficit is manageable. But all these amazing excesses now?

Why should any country have to pay back any other country's heavily excessive debt? Where is the legitimacy in that?

Have a good look at China's economics. Their banks are lending now. Their stimulus package appears to be working - they aren't throwing truckloads of money away for nothing. Their debt to GDP ratio is 18.4% - America's is 60%, but if you include all commitments to the US fiscal deficit - it works out to about 462%. Sound good?

So tell me now - is consumerism and debt a sound economic method? Or does the tenet of "Savings is the reward of Production" perhaps make you feel a wee bit more secure?

Mar 09 02:11 PM

[Firat Ünlü:]

Fully agree, what Keynesians don't see is how all the debt here and there eventually pushes the country over a cliff and makes it hard to finance the actual governemnt. You can play the charade as long as debt/gdp is at 60%, but there comes a time when you push it too far. One of the reasons why I will be leaving Europe is that I am not prepared to pay increased taxes that are the direct result of overspending decades ago.


On Mar 09 02:11 PM Bill Jencks wrote:

> Everybody is infatuated with Keynesianism. This is what got the US
> financial system in a mess in the first place. A little bit of inflation
> is good, a small amount of debt is OK, a small fiscal deficit is
> manageable. But all these amazing excesses now?

Mar 09 04:23 PM

[George Fiala:]

Dear Yamu,

I am just curious where you will be going? The US is no bed of roses, but maybe Australia?


On Mar 09 04:23 PM Yamu wrote:

> Fully agree, what Keynesians don't see is how all the debt here and
> there eventually pushes the country over a cliff and makes it hard
> to finance the actual governemnt. You can play the charade as long
> as debt/gdp is at 60%, but there comes a time when you push it too
> far. One of the reasons why I will be leaving Europe is that I am
> not prepared to pay increased taxes that are the direct result of
> overspending decades ago.

Mar 09 04:59 PM

[Firat Ünlü:]

I'm currently studying in Germany, will be moving to Austria for the master and move to Asia afterwards as my focus has been on Asia and economy, most probably I'll move to China as the quality of life is great. Some people really struggle there but I love it.
Once kids come into the equation it'll be a different matter, maybe Singapore? Australia sounds fine for later, but Asia's more exciting ;)
Been to Sweden last year and wouldn't really mind paying their tax rates if I got the same back in return. It'll be a trade-off between involving several factors deciding where to go should I leave Asia. US could have been an option but no longer looks that promising. Europe's too anti-business for my liking, I just don't like being in such a negative environment.


On Mar 09 04:59 PM George Fiala wrote:

> Dear Yamu,
>
> I am just curious where you will be going? The US is no bed of roses,
> but maybe Australia?

Mar 09 06:11 PM

[atlasman:]

Yamu - I love Australia but do not rule out New Zealand.

Mar 09 10:30 PM

[Bill Jencks:]

Yamu and George....Exactly right, Asia is the only place to be. Since all the wealth is now moving from West to East, then Asia is the place to be if you want any sort of life at all.

As an investor in Asia of some years, I realized 5-7 years ago that something terrible was coming to the financial markets. So I upped and moved from UK to the Philippines in 2006. I figured awhile ago that Asia was going to be the world economic powerhouse of the future and that the US weakness was that, because of her huge, rising annd unstoppable debt, America would somehow have to coax countries like China and Japan to buy more US Treasuries. This US dependency will be her downfall.

Since moving to the Philippines - because everything is so ridiculously cheap, I've barely felt the effects of the global financial crisis here.

I wrote an article about the Philippines showing reasons, monthly costs and expenditures, dos-and-donts etc. here:

travelandleisureabroad.../

Mar 10 02:46 AM