This is part 10 of my review of New Ideas from Dead Economists by Todd Buchholz. Here are parts 1 (Adam Smith), 2 (Thomas Malthus), 3 (David Ricardo), 4 (John Stuart Mill), 5 (Karl Marx), 6 (Alfred Marshall), 7 (Thorstein Veblen), 8 (John Kenneth Galbraith) and 9 (law and economics) if you’d like to look back. Any of the entries can stand alone, of course.
John Maynard Keynes was something of a polymath. He was good at almost everything he did and accomplished a wide variety of things over the course of his life. He’s an interesting, brilliant, yet polarizing figure. His ideas are quite controversial even today. His ideas are also so abundant, I had trouble deciding exactly what I was going to write about on this little blog o’ mine. Because he had so many ideas that contributed to economics, I’m going to isolate just one to briefly describe. Here are some of Keynes extremely controversial contributions: Don’t balance the budget, spend don’t save, the government should lower taxes and/or increase spending when the economy lags. Does that sound exactly like what we’re doing right now? It should – Keynes ideas were essentially the foundation of Roosevelt’s framework for leading us out of the Great Depression. Our current regime is essentially trying to take a page out of the Keynesian playbook.
One of the essential ideas that Keynes challenged was the connection between savings, investment and consumption. Keynes assertion was that savings hurts the economy. The traditional notion of savings is that as consumers save more, they put that money in the bank. Having extra money in the bank allows banks to lend more money, primarily, in theory at least, to merchants. Merchants, then, under the traditional theory, will borrow more money for investment.
Keynes, however, counters that (a) investment becomes less attractive when the economy is bad and (b) if the economy is bad enough, and enough people lose their jobs, they’re going to pull their money out of savings and spend it. As long as people have the potential to save money, surpluses have the potential to develop, and surpluses are a threat to the economy and have the potential to cause recessions. When a surplus exists, the cost of goods goes down. The profit margin for companies follows, and they’re forced to lay off workers to stay in business. The unemployment rate rises and the economy slows further. Keynes stated this as a rule – “depressions occur when the total demand for goods and services is less than total income.” Keynes worried that if demand falls enough that businesses will fire workers and reduce the output of goods. It’s a chain reaction best described by the Keynesian multiplier (which I’m not going to go into in this post).
So how can we get people to spend during a recession? One thing we already do is give unemployment benefits. This helps make things less volatile. When people have income from working they spend it. When they lose that income, they spend their unemployment check. When they’re employed again, the unemployment benefits stop. This fills part of the gap in spending that unemployment creates and makes the economy slightly less volatile (of course, the flip/negative side of the argument is that unemployment benefits create an incentive not to work or to fraudulently pursue them while people are working).
Another thing that can be done is deficit spending. Keynes thought the government could use deficit spending during recessions to prop up the economy. He basically thought there were two ways to do this – through increased government spending or by cutting taxes. In any case, recessions lead to lower tax revenues, so whichever you choose (increase spending, decrease taxes) the government will be involving themselves in deficit spending. Some politicians, notably Reagan, have longed for a bill that require that budgets be balanced every year. The problem with this, according to Keynes, is that during recessions you have less revenue. In order to balance the budget in a recession, you must do one of two things: (1) Lower spending, or (2) Increase taxes. Either of these things would deepen a recession even further. If the flow of money is slowing through the economy, a move to balance the budget, according to Keynes, is one of the most irrational things you could do (Keynes did support a balanced budget during good times).
The counter argument I’ve heard lately as to what’s going on with the Federal spending is that it targets the wrong people. I’ve heard at least one economist say that the current stimulus package will take people who are already employed and re-deploy them into other jobs, but won’t necessarily help the unemployed unless they acquire new skills. That argument doesn’t make sense to me, because if the other jobs still need to be done, they’ll find someone to do them, even if they have to pay someone to acquire the necessary skills.
In any case, for the reason listed above, and countless others, Keynes is one of the most interesting and controversial economists covered by Buccholz. Buccholz does a brilliant job of covering Keynes in this chapter. He explains a plethora of ideas more thoroughly and simply than I ever could. This chapter is one of his best. The subject matter probably helps, too. What are your thoughts on the current state of deficit spending? Was Keynes right? Thanks for reading.
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