On Keynesian Deficit Spending: Does It Work?
24 September 2011 | Pago Pago, American Samoa
Several have asked if Keynesian deficit spending works because there is so much conservative ideological commentary and propaganda against it, saying no. In a word, the answer is yes, most especially where national budgets are balanced over the business cycle. It works very well. The Neo Keynesian synthesis or theory (Keynes corrected by Friedman, in a nutshell) has only been around and applied expressly since about 1975 or so, but there are still earlier examples of its success and the failure which ensues when it is not applied.
A several volume treatise could be written on the topic. (Our's is not the only nation in the world, although most Americans seem to think so.) Scholars just haven't had the time. Only the ideologues question the utility of Keynesian stimuli done correctly and there is huge gobs of that on the web. much by the bogus "think tanks" I have written about. Serious scholars don’t really doubt it and are busy working, a few conservative and reactionary scholars excepted (Barro, Taylor and the Chicago crowd). RGE Monitor, a true think tank, counsels many nations, especially in Asia, on Keynesian stimulus programs, with very effective results.
The analysis can be framed this way: heading into a economic down turn, what should a nation do – (1) engage in a Keynesian deficit spending stimulus program or (2) seek to raise taxes and cut spending or deficits and move toward balancing the budget (doing nothing is never an option – governments will be shoved to one or another side of the line, invariably). The proof is resounding that (2) is a disaster (and was the reason for the second half of the Great Depression, as I have written here) and that (1) (a) avoids (2) and (b) generally has positive effects and multipliers greater than 1, most especially where budgets have been balanced over the business cycle earlier, as in most Asian countries. Here are some examples of what I say:
The huge deficit expenditures on WWII operated in Keynesian fashion to lift the US out of the great Depression.
In the US, the 1981 recession- Reagan's trillion dollar deficit. Supply side was a joke. Reagan lowered taxes and immediately raised them. The net decrease was less than 1% of GDP. Pure Keynesianism. The Reagan miracle was actually a Keynesian miracle.
The 1990s were the longest period of growth in American history. The collapse of the speculative dot-com bubble, a fall in business outlays and investments, and the September 11th attacks brought that decade of growth to an end. Despite these major shocks, the recession was brief and shallow because of the multiplier effect of deficit stimulus spending and eased monetary policy (too eased, in fact, as time went on).
The Obama’s too small stimulus deficit of less than $400 billion (cut in half by Republicans and then half of the $800 billion left was diverted by them into almost useless tax cuts so only $400 billion remained for stimulus expenditure, with 15% not even spent!), with its multiplier estimated by the CBO to be between 1 and 2.5, depending on which method was used (2.1 being deemed the best estimate by many) together with the concurrent bailout, kept us from falling into a Second Great Depression. Aggregate demand was collapsing at twice the rate it did during the start of the first Great Depression.
On the down turns in Asia, Canada, Australia, New Zealand, Germany and Russia after 2008 financial collapse, Keynesian deficit spending was used – very aggressively in Asia – and it worked very well in all those countries.
The austerity measures earlier imposed on Argentina and other Latin American countries by the IMF and World Bank, as conditions for loans, threw those countries into serious recessions where GDP fell disastrously and people seriously suffered.
Ireland and Hungary, two countries that were simply unable to borrow their way out of the 2009 recession like bigger economies. Both experienced significantly declining GDP in 2009. Ireland's gross domestic product tanked by 7.1%, Hungary's by 6.3%, from 2008 to 2009. The sad consequence was that their debt-to-GDP ratios actually worsened during that period, despite them frantically and mistakenly cutting back on government spending. The math is dauntingly simple: If a country has, for example a 100% debt-to-GDP ratio, a GDP reduction of 5% immediately increases this debt to GDP ratio to 105.3%, even if the government doesn't add a single dollar of deficit spending, i.e., debt.
The austerity measures being imposed on the PIIGS by the EEU and the fact they cannot now engage in deficit spending, lacking their own currencies, now threatens a EEU and perhaps a world financial system with collapse and us with a global recession. We'll see.
Too many are being brainwashed by conservative propaganda and ideologues, cuing on the Libertarian mantra that the government should never interfere in the economy. As his Monetary History of the U.S. shows, even Milton Friedman knew better than that. So does Neo Keynesianism which Friedman almost single handedly developed.