Keynes Is Redundant

The intellectual wellspring of so-called stimulus bills is the theories of John Maynard Keynes. Words like “pump-priming,” “stimulus,” and “expansionist” all relate to Keynes. In short, Keynesians believe that the normal business cycle can be managed by loose monetary policies and deficit spending during a recession. Likewise, restricting money and cutting government spending during a boom is advised, although politicians routinely ignore that side of Keynesianism.

Through such interventionist policies, Keynesians hope to abolish recessions and create stability. Government intervention is meant to act as a rudder, keeping the economy on course. Unfortunately, in all the decades of such experiments, Keynesianism has never worked. Most clearly, the US Great Depression lasted until at least 1938, and probably until 1941, despite deficit spending even greater than the Obama plan. What Keynes did deliver is creeping socialism. With each successive recession or even minor slowdown, politicians increase spending, pick business winners and losers, and generally tighten their grip over the private sector. Whether politicians’ motives are wholesome or just Emanuelesque exploitation of crises is largely academic.

That is not to say that the idea of an economic rudder is worthless. As usual, Milton Friedman has the answer. Friedman observed that consumer spending is uncorrelated with economic growth. Consumer spending does not increase as fast as the GDP during a boom, nor does it fall much during a bust. To allow this, the savings rate rises and falls with GDP growth. Friedman observed that consumer spending only increases once consumers perceive that their buying power has reliably increased. This sounds a lot like the Keynesian rudder, except consumers are vastly more careful of where they spend their money. Consumer spending is more efficient that government spending because consumers want value for their dollars, and politicians simply want power.

Better still, the consumer spending rudder is much larger than the Keynesians’. President Obama threw $785 billion at the current recession, while consumer spending represents 70% of the nearly $14 trillion US economy. No wonder a few far left economists say the Obama plan is too small; even if it were as efficient as consumer choice, it is still one twelfth the size of consumer spending. When people talk about the resilient US economy, they are mostly referring to the stability of consumer spending.

Interestingly, consumer spending is one of the reasons why FDR created the Great Depression. FDR’s failed attempts at micro-managing the economy caused a deflationary spiral that harmed consumer spending for decades to come. Other recessions, such as the “hungry” 1840′s, also correlate with the lack of stable consumer spending.

And now for the good news: consumer spending is rising. For the second month in a row, spending has increased, even as household income continues to slide. This is why the smart money suggests the recession has bottomed out (as evidenced by the recent broad rise in US securities). The natural sequence of economic recovery is GDP growth, later followed by higher employment, and later still higher real wages.

Still, politicians will clamor to “do more” to end the recession, even though it will probably be well over by the time the WPA shovels hit the dirt. So, if you feel a bit of springtime optimism, indulge yourself a little, for your feeling may be right. Also, tell the politicians that Keynes is no longer needed.