Thursday, August 25, 2011

Keynesian Economics vs. Regular Economics

This blog post is largely excerpted from an editorial in the Wall Street Journal of 24 August 2011 written by Robert Barro, an Economics professor at Harvard.

John Maynard Keynes was an economist of the 1930’s who propounded the theory that if the national economy begins to flag and recession is in the offing, the Federal Government should pump more and more dollars into the system. This supposedly will stimulate the economy and cause the recession to go away. To Keynes, it mattered not if the government had the money in the bank to spend on things in the economy. All the government had to do in such a situation was to print more money and spend it. He thought that by adding or subtracting dollar bills from the system, the government could control the economy and prevent radical swings from recession on the one hand and inflation on the other. He thought that the wealth of the government did not depend on how much gold it had in the bank; it depended only upon the strength of the general economy.

This economic philosophy has governed the fiscal decisions of the Federal Reserve Board and the Federal government since Franklin Roosevelt to the present, and it is very much alive and well in the present administration.

The present government has posited that it is necessary to transfer wealth to the people, in such things as food stamps, believing that this transfer of money will cause the people to use the influx of money to consume more and thereby stimulate food producers to make more food and hire more people, thereby increasing per capita income and stopping the recession.

“Regular economics” denies that this effect is a true conclusion of the matter. “Regular economists” believe that food stamps and other perks from the government only serve to motivate less work effort because the incentive to work is less if the government will just give the money away.

The problem with Keynesian economics is that there is no evidence that it works. Actually, we know something specific and concrete about the effect of one such transfer of deficit-sourced money. In 2009, the government raised the unemployment eligibility to 99 weeks—a significant increase from the previous eligibility period. After that, the long term unemployed (more than 26 weeks) jumped to over 44%. This pattern suggests that the dramatically longer unemployment insurance eligibility period adversely affected the labor market. The message people received was, “If they are going to give away the money, why should I work for it?”

I think the Obama Administration should rework their thinking about stimulus and transfer money. It is not working.

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