Archive for the ‘macroeconomic theory’ Category

Fed easy money punishes middle class Americans

September 27, 2012

John Maynard Keynes first noted that labor market equilibrium may be impacted by price inflation.  He noted workers’ strong preference for a 2 per cent wage increase in a 4 per cent inflation environment over a 2 per cent decrease in nominal wages during a period of constant prices. For many years politicians attempted to exploit this illusion by hiking up inflation rates.  Ultimately, the entire process collapsed in 1970’s stagflation, as the Phillips curve became upward sloping in price inflation/rate of unemployment space.

Money illusion has not disappeared, however, from the box of tools of the Federal Reserve. Indeed it is alive and well in the easy money policies emanating from the Fed since September 2008. Indeed, the Fed, under the chairmanship of Ben Bernanke, has becoming increasingly bold in exploiting money illusion. With inflationary expectations not yet rattled by the Fed’s $2 trillion balance-sheet expansion, Bernanke has now committed the Fed to an open-ended round of quantitative easing in the expectation of trading a little extra inflation for a little short-term employment.

These actions hurt the middle class – the group for which the policy is designed – as low interest rates sap their investment returns and as creeping inflation erodes their perceived real living standards.

“The more than five-fold increase in the median income of the American household since 1971, to $50,000 from $9,000, certainly provides the clear appearance of progress.  But after the dollar’s 82% loss of purchasing power over the same period is factored in, the median household income rose just 12%.  This much more modest increase is largely the result of the growing prevalence of two-income households.  The median real income for working men over the same 40-year period rose just 8%.  And thaat improvement only accrued to the ever-shrinking percentage of men fortunate enough to still have full-time jobs – just 67% according to the latest data from the Bureau of labor Statistics, within a percentage point of the lowest level on record since the figure was first recorded in 1948.”  Sean Fieler,  ‘Easy Money Is Punishing the Middle Class’, The Wall Street Journal,  September 27, 2012

As price inflation creeps upwards, from 2 per cent per annum to 4 per cent per annum, the price signals necessary for American workers to compete in the global market-place are dulled and incentives to re-educate and re-adjust are dimmed.  The end result is serious structural unemployment of the kind that now seriously hinders economic recovery in the United States. Ben Bernanke is the worst enemy that working Americans could ever wish to avoid. For he is working on their perceived cognitive deficiencies to gain short-term advantage for his Wall Street friends and cronies.


Definition of a hydraulic Keynesian economist

August 5, 2012

The term ‘hydraulic Keynesian’ goes back to 1949 at The London School of Economics.  After distinguished service during World War II, Alban William Housego  Phillips became a student at the London School of Economics, reading sociology.  An engineer by wartime training,  A.W.Phillips quickly became bored with sociology and switched his degree program to economics, focusing particular attention on Keynesian macro-economics..  While still an undergraduate student, Phillips developed MONIAC,  an analogue computer which used hydraulics to model the workings of the British economy. His model was well-received by Lionel Robbins, and Phillips’s career took off.  He advanced from Assistant Lecturer in 1951 to Full Professor in 1958. He then became famous as the founder of the Phillips  Curve that added the ‘missing equation’ to the hydraulic Keynesian macro-model.

The term hydraulic Keynesian relates to economists who tend to follow the early rigid models developed by disciples of John Maynard Keynes. This approach was epitomized by the early editions of  Paul Samuelson’s famous Economics textbook, which utilized the (in)famous 45 degree Keynesian cross diagram.  As Milton Friedman once wryly remarked, ‘Who knows how many students of economics have  ended up crucified on that Keynesian cross’.  The approach was consolidated by John  Hicks and  Alvin Hansen in the form of the real economy  IS/LM  framework that still dominates many an economics textbook.

Advances in macro-economics, that incorporated uncertainty and dis-equilibrium processes into macroeconomics and that recognized the relevance of inflationary expectations, significantly reduced the credibility of hydraulic Keynesian macro-economics during the late 1960s and early 1970s. The emergence of stagflation during the 1970s appeared to signal the death-knell for the approach.

However, following the 2008 financial crisis, a number of macro-economists – notably Larry Summers, and Christina Romer in the Obama administration –  who earlier had embraced  New Keynesian macro-economics –  reverted  to hydraulic Keynesian macro-economics infamously promoting the notion that the government expenditure multiplier was at least 1.5 and that the 2009 stimulus package would lower the U.S. rate of unemployment to below 8 per cent by the end of the year.


Wasting taxpayers’ money while ignoring unpleasant budgetary arithmetic

February 17, 2012

The United States Congress, in tandem with the United States President, is about to flush another $160 billion down the federal toilet.  Instead of honoring their oaths of office and crafting real budgetary reform, designed to avoid ever encountering the River Styx, these floundering self-seeking politicians are throwing yet another meaty bone to the electoral Cerberus.

A temporary payroll cut will do nothing whatsoever to leverage the United States economy into full recovery. Econometric results clearly indicate that only changes in permanent income generate consumption increases. Temporary increases in income typically are saved.  Absent the consumption boost, new jobs will not appear. Instead, the deepened long-term fiscal crisis serves to deter private investment, especially among upstart firms. And that is where economic recovery is always generated.

Medicare is already close to crisis and fundamental reforms are essential if  the system is to be rendered viable as the baby-boom generation access its resources.  A one-year fix for doctor’s medicare services futilely attempts  to paper over the hole in the funding dyke with rolled up toilet paper.  Extending unemployment benefits is a job destroyer that reduces incentives to search for jobs while further crowding out private investment.

It is a sad commentary on a presidential democracy that the entire political system freezes over during the final year of a failed president’s selfish scramble to hold on to an office that he  observably cannot handle. Winston Churchill may well have spoken too soon when he commented that ‘democracy is the worst political system conceivable, except for all the other alternatives.’  No doubt, Winston could not conceive of  a situation where someone as incompetent and as intellectually lazy  as Barack Obama would ever be freely voted into the Presidency of the United States.

Greg Mankiw responds to economics class walk-out by dumb Harvard undergraduates

December 7, 2011

Some weeks ago, I commented on the long-term decline and fall of Harvard College into a non-scholarly, ideological outpost for progressivism.  One knows that the Barbarians are  at the Gate when first year undergraduates walk out of a class taught by a leading New Keynesian economist, claiming that it is anti-Keynesian in its thrust. One understands the depths of anti-scholarship plumbed by the Harvard undergraduate admissions office when it brings onto campus know-nothing students who do not even realize that they know nothing about the world-renowned faculty member that they choose to disrespect.

Do not send your daughters to Harvard College, Mrs. Worthington!  They will join a better class of peers at the local community college.

The professor of economics disrespected by his students in this manner was Greg Mankiw, one of the world’s leading macroeconomists.  Greg Mankiw is not a free-market economist, and I have some reservations about his adherence to New Keynesian principles. But Greg Mankiw is one of the world’s finest macroeconomists and, even at this stage in my career, I should be privileged to sit at his feet in a classroom and share his thoughts and ideas.

I cannot express satisfactorily in words the utter contempt that I feel for those Harvard undergraduates who walked out on the teachings of a maestro.  It makes me shudder to contemplate the low-grade protoplasm that Harvard College is now inviting to share its cloisters.

On December 4, 2011, Greg Mankiw responded officially to the Harvard College walk-out in a New York Times column. The link is as follows:

This a dignified response by a a very classy scholar. Would it not have been heart-warming if the Harvard College admissions officers had appended a word or two in support of this gifted professor, who has been abused by the trash that they have deliberately brought to the Harvard campus?

The Nobel Committee surely knows how to pick progressive economists

November 13, 2010

“The Congress shall have the Power…To regulate Commerce with foreign Nations, and among the several states, and with the Indian tribes.” Article I, Section 8 of The Constitution of the United States

The above-cited words are sufficiently clear, one might think, that even a mathematical economist should be able to comprehend them.  Congress, as an institution endowed with strictly enumerated powers, is constrained by the Commerce Clause to intervene only where inter-state commerce is affected. Where no commerce is anticipated at all, and surely is not anticipated to cross state lines, the Congress has no authority. If it intervenes in such circumstances, it violates the Constitution. The Federal courts, under such circumstances, are expected to patrol the borders and to fell the unconstitutional legislation.

This simple constitutional message, apparently, is beyond the comprehension of three winners of the Nobel Prize in Economic Sciences – Kenneth Arrow, George Akerlof and Erik Maskin. All three have just asked for permission to file a brief supporting the Obama administration’s bid to terminate a lawsuit that challenges unconstitutional clauses in its health care reform legislation. 

Nineteen states have joined in the lawsuit brought by Florida Attorney General, Bill McCollum, on March 23, 2010, claiming that the Patient Protection and Affordable Care Act (ACA) unlawfully forces individuals to buy health insurance.  This lawsuit has gained some traction in the courts, and progressive socialists across the Nation are rushing in to make sure that the constitutional constraint is violated. 

 Foremost among these progressive socialist petition filers are Arrow, Akerlof and Maskin. Their petition  intervention should come as no surprise. Each of them is so removed from an understanding of market economics that the only surprise is that they have not long-ago migrated to North Korea or Cuba to indulge their socialist fantasies. In mitigation of their decision to remain in the United States, I assume that dwelling in the non-market confines of Stanford University, the University of California at Berkeley and the Massachusetts Institute of Technology is the next best thing (and a whole lot more comfortable I should add).

Kenneth Arrow’s early work focused attention on the public goods characteristics of health care and of research and development. In both cases, he recommended comprehensive nationalization. Wow!  folks, can you just imagine how far ahead of the rest of the world the United States economy would have forged with all its R & D locked into government agencies!  Can you imagine how happy Americans would now be if they shared with Britain the wonders of a National Health Service!  To borrow a George W. Bush aphorism: ‘Your doing a great job, Kenny-boy! ‘  Those Swedes just love Kenneth Arrow.  For he completely understands just how brightly shine the Northern Lights!

George Akerlof  has yet to discover a private market-place that is not riddled with asymmetric information. All those lemons leave him with such a bitter anti-capitalist taste. Asymmetric information, however, is strictly limited to the private market-place! For George Akerlof just loves big government and worships at the King’s College shrine of Maynard Keynes. Boy, if Maynard had only known about the universality of efficiency wages and menu costs!  Well, those progressive Swedes quickly cottoned on to what could be done with those macro misconceptions.

Eric Maskin is a mathematician (A.B. in mathematics and Ph.D in applied mathematics)  who now masquerades as an economist. Naturally, he has drifted into the high-tech field of mechanism design theory, confident that  abstract mathematics can replace market process. Friedrich von Hayek and Ludwig von Mises – with all those vons, are they some Nazi-leftovers from the Third Reich? Neither of them would recognize a differential equation if they saw one!  Was it not Silent Cal Coolidge who once spoke out to label Herbert Hoover (the Great Engineer) Wonder Boy!  And my, my, how well Herbert served his country following the 1929 financial crisis! Just think what a mess things would have been had Calvin Coolidge still been in office. Just think of the economic performance of the United States during those Roaring Twenties!  Oh!  On second thoughts, perhaps we had better file a suit against that information becoming public knowledge!

Well, that is the petition that I would file to the Florida court, had I any standing whatsoever, which I surely do not.  It would be a petition asking the Court to ignore the advice of exceptionally foolish economists, who live exceptionally lucratively and freely under capitalism, while hypocritically deriding its continued existence and demanding oppression for their fellow citizens.

Never Let A Good Crisis Go To Waste

October 19, 2010

 Never Let A Good Crisis Go To Waste

Readers who have been following my daily weblogs may be interested in my new book: Charles K. Rowley, Never Let A Good Crisis Go To WasteThis book is published today by The Locke Institute. It  contains the best of my columns, carefully edited and organized by themes, in a 250 page paperback book.  The book sells at $10 plus postage from and (by check only at $12.50 inclusive of postage ) from The Locke Institute, 5188 Dungannon Road, Fairfax, Virginia 22030, USA.

The book consists of 93 columns presented under the following themes: Part One – Political Philosophy, Part Two, – Public Choice, Part Three – The Long Shadow of John Maynard Keynes, Part Four –  The Burden of the Public Debt, Part Five – Valley of the Dolls: Stimulants and Depressants, Part Six – Money Mischief, Part Seven – Dry Rot in the United States Housing Market, Part Eight – Hot Air Creates Global Warming, Part Nine – U.S. Health Care in the I.C.U. and Part Ten – Progressive Socialism in the United States.

Readers will note that the Front Cover portrays the Three Villains who publicly agreed to take advantage of the recent Economic Crisis : President Barack ObamaChief of Staff,  Rahm Emanuel and Secretary of State,  Hillary Clinton.

Does the Fed have an Anti-Inflation Exit Strategy? 2

February 7, 2010

In yesterday’s column,  I outlined the problem that now confronts the Fed – the direct consequence of monetary expansion along unconventional lines – and Allan Meltzer’s proposed solution.  In this column I shall outline the monetary model that, in my judgment, defines the terms on which the Fed must retract  its over-expansion, and the public choice model that will determine why required  monetary contraction is unlikely to occur. In tomorrow’s column, I shall outline the predictable consequences for the economy of the United States.

The key monetary theory question that must be addressed is: can the Fed contract the money supply significantly without imposing a short-run increase in the rate of unemployment?  The one word answer is, no. The relevant model is that enunciated in 1971 by maestro Milton Friedman in The Journal of Political Economy under the title: “A Monetary Theory of Nominal Income”. Friedman’s paper is technical, but I shall explain it as simply as possible by reference to a basic quantity theory equation:


where M is the quantity of  high-powered money, V is the income velocity of circulation of that money (defined as the number of times money turns over in the real economy during a specified time-period), P is the aggregate price level, and Y is the level of real output or gross domestic product.

As written above, the quantity relationship is not an equation but an identity; that is to say, it will always hold just as 2 always equals 2. It becomes an equation, a falsifiable hypothesis, if you will, by asserting something more specific about the nature of the relationship.  For our purposes, three alternative sets of assertions are worthy  of consideration:

In the first case, advanced by Irving Fisher during the 1920s, V and Y are constants, determined outside the system. So any change in M, upwards or downwards, impacts P, and P alone. This is known as the classical dichotomy, namely that only real factors impact the real economy and nominal factors affect only the nominal values of real factors. If Fisher’s theory were to hold, then  Bad Ben indeed could contract the money supply without impacting adversely on Y (and unemployment levels).  But alas,  it does not hold, as was demonstrated conclusively over the period 1979-1982 when Paul Volcker’s monetary contraction lifted the level of unemployment in the United States to 10.8 per cent, well  above the level currently observed in 2010.

In the second case, advanced by Maynard Keynes in 1936, or rather by his undisciplined  so-called disciples during the 1940s and 1950s, P and Y are constants determined outside the monetary system and M and V always completely offset each other. If M rises, V falls and vice versa. So, one cannot push or pull on a string, and monetary policy is completely ineffective. If this theory were to hold,  Bad Ben could do whatever he liked.  No one would care. His interventions would exert no impact on the economy.  Unfortunately for Bad Ben , however, the  theory is false,  as Friedman and Schwartz’s magnificent Monetary History of the United States clearly demonstrated.  Inflation is always and everywhere a monetary phenomenon.

In the third case, correctly advanced by Milton Friedman in 1971, if M changes, then V moves somewhat in the same direction, accentuating any shift in M. This combined movement on the left-hand side of the equation manifests itself in a same direction movement on the right-hand side, primarily on P,  but somewhat on Y,  in the short-run. In the long run, the LHS movement impacts solely on P alone  (the return of the classical dichotomy). This is the theory that almost all Americans embrace, as Wall Street reactions to Fed statements clearly demonstrate. It is the theory that puts Bad Ben in the hole, and that should concern all of us as the Fed ponders what to do about impending inflation.

So the definitive response  is that Professor Meltzer is right.  Bad Ben undoubtedly confronts a trade off between lower inflation and higher unemployment if and when he enters the money market to mop up the excess supply of money  that he has so recently loaded onto the US economy.

As I have mentioned earlier, Bad Ben‘s dilemma is worse than this. Because he purchased toxic mortgage-based securities instead of Treasury notes, when expanding the money supply, no doubt he will attempt to sell those back to the market should he decide to attack inflation.  But suppose the market values those securities at zero, as well they might, and as the failure of the TALF program suggests it will. Bad Ben will be unable to make a dent in the supply of money by his pathetic yard sale.  He may be forced to sell off all his remaining Treasury notes, effectively bankrupting the Fed, while still leaving significant inflationary pressure in the US economy. By that time Bad Ben would be political toast, a prospect that has considerable public choice significance for Bad Ben‘s predictable decision when inflation bites.

Finally, I turn to the public choice issues that surround the Fed’s choice between inflation and increased unemployment. A fundamental insight from public choice is that politicians always prefer solutions that involve concentrated benefits and dispersed costs over solutions that involve concentrated costs and dispersed benefits.  That preference is indelibly ingrained in the gene pool of political survivors. Think now about Bad Ben‘s alternatives.  If he attacks inflation successfully with his toxic assets, he raises  mortgage interest rates directly, by saturating the market with existing mortgage securities. Down comes the housing market once again, this time coupled to a dramatic collapse in the commercial securities market. The population at large benefits to a much more limited immediate extent  from reduced inflation.  Dear Readers, this scenario wipes out Obama in 2012 and Democrat-majorities in Congress for decades to come.  What do you think that Bad Ben will do given his track record at the Fed?

In my concluding column, tomorrow, I shall outline just what Bad Ben predictably will do and the consequences for the United States economy.

Why Demand Stimulation Has Failed: New Keynesian Insights

January 23, 2010

I have explained in recent columns how hydraulic Keynesians promoted the case for fiscal intervention, through increased public expenditure and rising budget deficits, as a response to under-full-employment equilibrium under conditions of price stability.  Once inflation raised its ugly head during the 1950s,  as a consequence of excessive expansion of the money supply designed to accommodate rising budget deficits, these same Keynesians  honed in on another exploitable opportunity: governments should exploit nominal wage rigidities to purchase a lower rate of unemployment at the price of (in their minds a tolerable) increase in the rate of price inflation.  In essence, government should take advantage of a gullible work-force that would fail to recognize  inflation-induced reductions  in the real wage that would encourage firms to increase output.

Governments – always eager to take advantage of a free political lunch – fired up both the monetary and the fiscal furnaces to drive their economies beyond the natural rate of unemployment.  For a time the strategy seemed to work.  In the United States, however, the policy ran into serious headwinds when President Johnson simultaneously pursued war in Vietnam with a Great Society program.  Inflation appeared to take on a momentum of its own and, by the end of the 1960s, it was out of control.  Milton Friedman and Edmund Phelps explained the nature of the problem in terms of adaptive expectations models.  Expectations, henceforth, would move center stage as an era of stagflation dampened the efficient functioning of macroeconomies world-wide. The days of the hydraulic Keynesians were over – at least that is what almost every major economist believed;  until September 2008.

Adaptive expectations just would not cut the mustard, as economists now rushed to investigate the micro-foundations of macroeconomic theory.  Drawing on an idea advanced earlier by John Muth, Robert Lucas and Thomas Sargent re-wrote macroeconomics in rational expectations new cloth:  individuals in society optimally use all available information, including information about current government policies, to forecast the future.  Because monetary and fiscal policies influence inflation, expected inflation depends on such policies. 

With such knowledge in the hands of the people, governments seemingly cannot exploit a Phillips Curve.  In the New Classical macroeconomics, governments are impotent to influence the level of macroeconomic activity through sysematic policy interventions. Only by surprise can they make an impact. Ironically, this pits the government against the people in an ongoing strategic battle that was never supposed to reflect the nature of democracy!  The New Classical macroeconomics had launched a new Star Wars in the unending battle between mercantilism and free markets.

Initially, the Keynesians ceded the battle-field to the New Classicals, acknowledging, as economists must always  be tempted to do, that rational expectations was the only game in town.  But not for long.  By the late 1970s, the Empire struck back, as Keynesians rose like Phoenix from the ashes in a New Keynesian form. A new brand of Keynesian, now immersed in rational expectations, searched high and low for any nominal rigidity that might arguably survive in the Brave New World.  Larry Summers and Christina Romer were right there, with other leaders such as Gregory Mankiw, David Romer and John Taylor. And my, how contemptuous these New Keynesians were of the old-fashioned hydraulic Keynesians who struggled valiantly to compete with them in separate sessions at the annual conventions of the American Economic Association!

Well, the New Keynesians were quite successful. The Empire restored its rightful position, and the New Classical Jedi failed to take revenge. By the mid-1990s, governments once again pursued active monetary and fiscal policies as tools of macroeconomic stabilization policy.  But they did so on a reduced scale.  For even the most ardent New Keynesians recognized the fragile nature of their new nominal rigidities: staggered wage contracts that exposed workers to a modicum of real wage reduction, efficiency wages whereby firms attempted to hold on to superior labor by paying it above market rates, and menu price rigidities that exposed firms to a modicum of inflation-induced sales expansion, as government surprised the system with accelerated inflation. But policy leverage  through this mechanism must be limited, and transient, since  workers and the firms would eventually catch on to the government’s game, with labor shortening  the duration of labor contracts, and with firms revisiting their efficiency wages and menu prices more frequently,  in response to government manipulation of the macroeconomy. 

The proof of the pudding, of course, is in the eating. The year 2009 has left the Obama administration and the Democrats in Congress with severe indigestion and acute intestinal discomfort.  The temporary tax cuts have been pocketed, not spent, by debt-burdened households. Federal stimulus monies have been absorbed by the states  in reductions in their own projected outlays, and by firms who have replaced privately-funded with federally- funded labor. Stated goals of unemployment reduction have  proved worthless. Reckless Federal Reserve outlays in purchasing toxic mortgage securities have served only to promote the issuing of ever more volumes of such instruments by agencies of the government. Increases in the money supply have been hoarded by the banks, while good entrepreneurial initiatives are starved of funding. 

Now dear reader, think just how useless demand stimulation by government is in a post-2008 environment where inflation is all but non-existent, where market pressures are such that wages and prices are only too evidently downwardly flexible as workers scramble to hold on to their jobs  and as firms scramble to hang on to their markets in a severely recessed economy. If not before the recession, certainly now, we live, at least temporarily, in a New Classical environment.  

Do you believe that once leading New Keynesians such as Larry Summers and Christina Romer experienced a limited attack of Alzheimer’s,  forgetting their own scholarship,  and retreating  into a hydraulic Keynesian fantasy, when advising President Obama and Chairman Ben Bernanke to engage in reckless, wasteful and essentially impotent monetary and fiscal outlays?  Or do you believe that they were acting not as economic, but as political, advisors to a President and a Congress desperate to exploit a financial crisis as a means of expanding the  power of the state?

Why Obama’s Stimulus Package Has Failed 2

January 22, 2010

Maynard Keynes was not a God, not even a Son of God, as so many of his immediate disciples appear to have believed.  Like everyone else, he was just a human being.  Unlike his disciples, however, Keynes was really smart, with a flexible mind that adjusted rapidly to changes in the economic environment.  Unlike his disciples, Keynes regularly left his academic cloisters at Kings College to engage significantly in the real world. He did not dwell monk-like, exclusively in the unrealistic world of a cloistered intellectual prison.  So Keynes was well aware that  general price levels move up and down in response to economic circumstances, sometimes violently so.  How could anyone with eyes not be so aware, living, as he lived, through the volatile years book-ended by the two Great Wars? 

The much dimmer bulbs that worshipped at his Shrine do not appear to have embraced that knowledge, or at least must have suppressed it because it did not fit well into the mechanistic figments that captured their fevered minds.  For the early disciples – Alvin Hansen, John Hicks, Paul Samuelson – the macro-economy was a peculiar laboratory, an environment in which all prices, be  they wages, product prices or interest rates, were always rigid downwards, irrespective of the level of aggregate demand, an environment in which economies more or less  were permanently under-employed, and where, therefore, inflation safely could be ignored.  In such a world, aggregate demand alone drove the level of activity in the macro-economy.  Aggregate supply was some passive agent, a 45 degree line in real income-real expenditure space,  responding phantom-like to changes in demand. 

Thus was born the notion of the inverted L;  thus were countless numbers of economic majors crucified on (St. Paul)  Samuelson’s Keynesian Cross;  thus were the same countless legions indoctrinated into the curious cult of  an IS-LM world, a world in which everything is real, where real and nominal values are identical, and where there is no role for price as an adjustment mechanism.

I often reflect sadly on how many of the minds of the more inquiring freshman must have became distraught as they fought to reconcile the two halves of Samuelson’s introductory text, the one (microeconomics) where prices played  a key equilibrating role and the other, macroeconomics, where they played  no role whatsoever. No wonder that so many so-called cutting-edge economists appeared to verge on the borderline of schitzophrenia, as they moved from microeconomic to macroeconomic analysis.

Well, it turns out that the IS-LM cult of hydraulic Keynesianism was perfectly adapted to the notion that a fiscal stimulus is the only mechanism capable of moving an under-employed economy to full employment. For, with interest rates inflexible downwards, the economy is locked in a liquidity trap and money does not matter; one cannot push on a string. Even if one can  push slightly on a string – let us not be too observant since a modicum of modesty is quite becoming – investment will not respond much, if at all,  to interest rate adjustments. 

Thank God, therefore, for Big G, the Holy Grail of the Keynesian Religion.  Fire the fiscal furnace, raise taxes as necessary, and rely on the balanced budget multiplier to do the job.  And since we Saltwater Economists worship FDR, and are enamored of big government, what’s not to like in this Brave New World?  In the famous words of Harry Hopkins, FDRs loyal spokesman (and closet communist):  “We will tax and tax, and spend and spend, and elect and elect”.  (Well, in retrospect, as Massachusetts recently has demonstrated, maybe not always elect and elect!)

I have labeled this column, Why Obama’s Stimulus Package Has Failed, notwithstanding the thrust of the column itself, because I am supremely confident that you, dear reader, will see through the fraud that was perpetrated upon an unwary Western World.  That the fraud lasted some 15 years, before it was exposed for what it is, is testament to the fact that we are all human beings, and that we are all capable of suspending reason when confronted by arguments from people that we are taught to revere.

In any event, in tomorrow’s column, I shall dissect the Keynesian cult in terms of its much superior, if still flawed successor, New Keynesian economics…

Why Obama’s Economic Stimulus Package Has Failed 1

January 21, 2010

Any President of the United States who flushes close to $1 trillion of taxpayers’ hard-earned wealth down the toilet during the first hundred days of his administration surely must expect tough political sledding for the remainder of a single term administration. The capture of the governorships of Virginia and New Jersey were the first  Republican Party green shoots from  this significant  presidential economic failure.  Martha Coakley croaking on her way to the Senate in the People’s Republic of Massachusetts is the writing on the wall both for the President and for the Democratic majority in the United States Congress.

Obama’s stimulus package has failed lamentably on its own clearly-stated terms: “You ask what is my aim?  My aim is to stem the rate of unemployment by late 2009 nation-wide at no more than 8 per cent and to bring it down quickly thereafter to a rate enjoyed during the mid-2000s.  This package will achieve that goal.”  Well, with unemployment stalled at 10 per cent, and threatening to rise during the first half of 2010, with the United States and the United Kingdom – the two big Keynesian spenders among the G20 nations – the last to stagger out of recession, and with the United States now confronting  its worst debt crisis since the end of World War II, major planks in the president’s economic policy platform are riddled with dry rot.

Choices matter in the competitive environment of Presidential politics. Bad choices have serious consequences. And President Obama made terrible choices in his selection of Larry Summers and Christina Romer as economic policy advisors.  As if in a 1960s time-warp, Obama chose two out-of-date hydraulic Keynesians to prepare and to promote his rescue package for an ailing US economy. Predictably, the hydraulic Keynesian policies that they have promoted, and continue to promote,  in the teeth of adverse evidence,  have failed and will continue to fail to produce economic recovery, indeed will slow down the natural recovery of an unimpeded, still resilient market economy.

For the most part, I do not share the enthusiasm for New Keynesian rational expectations that many of the best economists in this country now endorse.  However, New Keynesianism is infinitely superior to the hydraulic Keynesianism promoted inter alia  by Alvin Hansen, John Hicks, Paul Samuelson, James Tobin and Robert Solow.  So for the sake of argument, I am going to put myself into New Keynesian shoes and speculate how much better would be Obama’s future political prospects had he chosen leading New Keynesians and not worn-out old Keynesians to be his policy advisors.  Specifically, I have in mind the two most brilliant New Keynesians in the United States, namely, Gregory Mankiw and David Romer.

Well here would have been their warnings to the President had he flirted in their presence with old-fashioned Keynesian nostrums:

“new Keynesian economists do not necessarily believe that active government policy is desirable.  Because the theories developed in this book emphasize market imperfections, they usually imply that the unfettered market reaches inefficient equilibria.  Thus these models show that government intervention can potentially improve the allocation of resources.  Yet whether the government should intervene in practice is a more difficult question that entails political as well as economic judgments.  Many of the traditional arguments against active stabilization policy such as the long and variable lags with which policy works, may remain even if one is persuaded by new Keynesian economics.”  G. Mankiw and D. Romer, New Keynesian Economics Volume 1, 1991, 3


“Of course, there are also disadvantages to the Keynesian approach to modeling.  Without microeconomic foundations, welfare analysis is not possible.  More importantly, specifying aggregate relationships directly may cause us to overlook important effects.  For example, stating directly that consumption depends on current disposable income neglects the possibility that temporary and permanent income movements may have different effects; similarly, it neglects the possibility of Ricardian equivalence.  When consumption behavior is derived from microeconomic foundations, in contrast, these possibilities are immediately apparent.  Finally, aggregate relationships may change when the structure of the economy or the nature of policy changes.  Thus, working with aggregate relationships rather than microeconomic assumptions may lead us astray in assessing the likely consequences of changes in policy.  This is the basis of the Lucas critique of traditional macroeconomic models…”  D. Romer, Advanced Macroeconomics, 1996, 196-197.

These are far from ringing endorsements of hydraulic Keynesianism. For the non-economist, the passages may well seem to be opaque. I shall make use of my writing skills in the next two columns, however, to make their meaning crystal  clear in a  careful New Keynesian critique of Obama’s economic stimulus policies.