How Keynesian Are We?

June 5, 2010

Last year, Congress passed the American Recovery and Reinvestment Act (or ARRA), known colloquially as “the stimulus”. Justifying this massive federal outlay ($787 billion over a couple years) was the ongoing economic meltdown following the mortgage and financial crises and the predicted decline in output and upsurge in unemployment (here’s Krugman’s pessimistic and, in retrospect, relatively accurate take). Obama signed the bill, and the federal government began spending (well, ramped up spending). A year and a half later, economists are debating the stimulus and its effects (e.g. Glaeser at the NYTimes Economix blog). 70 years later, the debate still rages – does Keynesianism work? Can we spend our way out of a recession? New and old estimates of the effects of various programs (the New Deal, Kennedy’s tax cut, etc.) are bandied in a debate that shows no signs of abating (though it may have gotten a bit more humorous).

Here’s my question though: is ARRA enough to label the current situation a Keynesian stimulus? Clearly, the act increased Federal spending from what it would have otherwise been. But the Federal government is not the whole of public spending. In fact, a quick glance at the National Income and Product Accounts Table 1.1.2. Contributions to Percent Change in Real Gross Domestic Product shows that total government expenditures have actually decreased for the last two quarters, with only contributions to growth the two quarters before that (Hat Tip to Mark Thoma). State and local governments, mostly constrained by balance budget amendments, have been slashing spending almost as fast or faster than the federal government could ramp it up. The trajectory that the US economy takes over the next couple years will be a key data point in debates about Keynesian spending and the like. And yet, when you look at the numbers, the whole thing seems a bit… small. The government as a whole is much larger than it was in 1929 or 1932. But the changes from the trend are tiny. For example, also according to the NIPA, total government spending rose 12.8% in 1934, which in turn contributed 2 percentage points of the increase in GDP.

(To clarify, the contributions I am talking about here are direct ones – there is no way to track inside the NIPA any multiplier (positive or negative). Rather, the NIPA simply calculate the growth in total GDP and then derives arithmetically how much each portion (consumption, investment, government, trade) contributed to the increase. Calculating the multiplier is a much-debated problem in macroeconomics, but I would think a subsequent one to establishing just how much government spent in the first place.)

In short, the New Deal was a big increase in spending in a much smaller government. The ARRA was a big increase in federal government spending that (almost) made up for a big decrease in state government spending. So the question is, how Keynesian are we? How Keynesian have we ever been? And perhaps of more interest for the crowd that reads this blog, why does popular perception maintain that government spending has increased dramatically when the official figures show very modest changes? I think it might have something to do with the focus of media on the federal government, and the failure to aggregate up local issues (laying off teachers and cops and the like) into their macroeconomic effects. But I’m not entirely sure. Also, what should the proper baseline be to compare the effectiveness of a stimulus against – a world where government expenditure was flat, or a world where government expenditure did what it would have without the stimulus (i.e. go way down due to cutbacks at the state level)? There are some interesting questions here, I think, in the realm of civic epistemology.

5 Responses to “How Keynesian Are We?”

  1. danielbeunza Says:

    Dan — two comments.

    From a banker friend of mine: the real question should be “how Keynesian can we be?” … given that we have surely spent all the stimulus money.

    And here’s one from me: “how kenyesian should we be?” given that the conceptual problems of keynesianims (the Lucas critique, which argues that economic actors will eventually figure out that the stimulus money the government spends is coming from their pockets) still holds.

    • I’m fairly convinced by the “things are different at the zero-lower bound” argument. Previous attempts at overt Keynesianism in the US, e.g. Kennedy’s tax cut, have been slow relative to the length of the recession they were trying to fight, and were fighting recessions where the fed rate didn’t stay at ~0% for long periods of time. So, I think there is some logic behind comparing the New Deal moment and the current moment, and claiming all other cases are a bit different. The answer to “how Keynesian should we be?” is unknowable, of course, but my point is that we are having that debate largely with questionable conventional wisdom that flies in the face of official data about what’s actually happened so far, in re: government spending.

  2. danielbeunza Says:

    I understand your point, and I think it’s worth exploring. My own interest, however, is in developing a sociological understanding of macroeconomics; it is, after all, the most natural extension of the social studies of finance.

    The payoffs could be tremendous. Here’s why: to a large extent, the effectiveness of the IMF and other macro policies reliy on impression management and enactment — not just improving the “fundamentals” but especially calming the market.

    One can see this in the case of the Asian crisis: some of the policies pursued by the IMF –such as forcing the brother of the president of Indonesia — were aimed at reassuring foreign investors (eliminating “crony capitalism”) but also created a confidence crisis and capital flight among the locals (if the brother of our president loses his job, whose job is secure?).

    In the current crisis, the benefits of the shock cutbacks in public spending are not simply savings but also sending “the right signal.” And clearly, there is ample room for interpretation of what that signal is.

    Now, back to Keynesianism. Keynes’ initial idea was a kind of “embryo behavioral economics:” it is based on the view that people suffer a bias, monetary illusion. The orthodox alternative (rational expectations) is equally unsatisfactory. What a sociological theory of the interpretive processes in macroeconomics could provide is a way to explain why government spending works sometimes, and fails to work in other times.

    Here are some questions that a sociologist can ask:

    1. how do people, in practice, navigate crises?

    2. what material tools do they employ?

    3. what is the role of the capital markets in these interpretive dynamics? i.e., interest rate spreads rise, what is the outcome?

    … and so on.

    • Daniel,

      I am, of course, completely on board with the sociology of macroeconomics. Give me a few years, and I hope to have a book on it!

      I think you quite right about issues of impression management, etc. “Credibility” is hugely important, and pursued aggressively. The history of the Federal Reserve contains many examples where (post-hoc) seemingly reckless policies were pursued in the interests of credibility, and credibility and transparency are at the heart of how the Fed still manages to move markets without looking like it’s pushing too hard (Greta Krippner’s “The making of US monetary policy: Central bank transparency and the neoliberal dilemma” is an exemplar here).

      In re: Keynes – I don’t think I’ve read enough yet to know what his view was. I wonder sometimes if he is a figure much like Marx – thousands of conflicting interpretations, yielding as much heat as light.

      One issue that I think will plague the sociology of macroeconomics, as it plagues macroeconomics itself, is the relatively large number of important actors coming from all walks of life – economists, politicians, journalists, brokers, CEOs, even the “representative agent” so beloved in macro models. I worry that “following the actors” will be a more difficult task, with less distinct boundaries, than (say) examining a particular financial market. Your example of the Lucas critique is a good one – economists, in order to do economics, are trying to also be sociologists, and predict how groups and organizations will respond to policies, which in turn requires a theory of how consumers themselves process economic information. It’s sociology of knowledge all the way down!

      Anyway, I look forward to continuing this conversation – there are clearly a lifetime’s worth of issues to be dealt with here!

  3. Yuval Says:

    If I understand correctly, according to Keynesian economics, the size of government intervention is not the most important factor, but to the degree to which such intervention In such a situation brings about an increase on aggregate demand, which in turn increases economic activity and reduces unemployment and deflation. So, has ARRA-derived policy done that? Not to the best of my knowledge. So, no – the Obama administration is not Keynsian in the sense that it did develop New Deal-like programs that would kick-start the real economy and would provide infrastructure for long-term growth. Compare ARRA with things like the Public Works Administration, Civil Works Administration and, maybe most importantly, the Wagner Act (National Labor Relations Act).

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