The Second Coming of Keynes

Senior Fellow
Kevin A. Hassett

As the world's economy has entered a dramatic slowdown, an interesting Keynesian revolution has taken shape. Up until recently, there was wide consensus among macroeconomists that activist fiscal policy was inadvisable. Princeton University's Alan Blinder, for example, wrote in 2004 that "virtually every contemporary discussion of stabilization policy by economists--whether it is abstract or concrete, theoretical or practical--is about monetary policy, not fiscal policy." Blinder went on presciently to question this consensus, but even he cautioned against relying too much on spending, stating that "if Congress decides to stimulate economic activity by building more public infrastructure, the natural spend-out rate of such programs will probably be very slow."

President Obama's economists have disputed that consensus. It was recently reported, for example, that Christina Romer, chairwoman of the Council of Economic Advisors, said "aggressive, well-designed fiscal stimulus is critical to reversing this severe decline." The New York Times helpfully added: "The vast majority of the nation's economists agree that one is necessary, and soon."

Statements such as these have been echoed by economists throughout the Obama administration, and by the new director of the Congressional Budget Office, Douglas Elmendorf, in recent congressional testimony. This apparent unanimity has had an enormous effect on the design of the current stimulus package, which calls for massive spending increases along with tax cuts.

The statements are not, strictly speaking, true. Monetary policy has pushed the economy as far as it can, but fiscal policy need not rely only on the Keynesian bag of temporary tricks.

The accompanying chart documents how dramatic this turn of events has been. It tracks the increase in government spending that occurred in each past recession (in blue) and the increase planned for the current recession. For scaling, all numbers are expressed relative to overall GDP. Until this year, the biggest countercyclical government-spending program in history was in the 1981-82 recession, when government spending increased by a bit more than 2 percent of GDP. In this recession, the increase will be approximately three times that.

The truth is that there is very little empirical support for policies such as these. They will likely provide a small boost, at an enormous cost. When the boost is gone, the cost will remain.

For those economists who are more skeptical of the theories of John Maynard Keynes, there is but one consolation: An experiment this large will provide ample opportunity for study.

Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.

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