Thursday, October 13, 2011

"Small Government Keynesian" is not an oxymoron...

I think there is some confusion in the comment thread of this post over the point I made that your view on Keynesianism has little to do with your political ideology.

To be a "Keynesian" all you really need is to think that liquidity preference is an important determinant of the interest rate, the level of effective demand is an important determinant of output and employment, that as a result of shifts in liquidity preference and effective demand the economy can be below full employment for extended periods of time, and that when the economy is below full employment, spending of any variety (including government spending, but also investment and consumption spending) can have a multiplier effect on output that is larger than it is during boom years.

That or a substantial subset of that is what it is to be "Keynesian".

If you have moral or philosophical reservations about the government taking action - any action - to respond to economic downturns, that's fine. Notice that nothing in that prior paragraph requires you to support government action.

If you think government is likely to bungle spending so badly that the inefficiencies and misallocation of government spending will swamp any spending mulitplier, then it's perfectly reasonable to be a Keynesian that expects the fiscal multiplier is small.

I personally rarely think about the size of government, I think government should be more active in some areas and less in others, and I think constitutional restraint of government, decentralization of power, and democratic decision making are essential. I don't want a large government, and I don't view government as having any special competence. None of that really informs what I think about macroeconomics - in fact it's entirely irrelevant to what I think about macroeconomics - but that philosophy of government in addition to my assessment of macroeconomics are of course going to both inform any sort of policy claim I advocate.

8 comments:

  1. As a related note, government spending as a % of GDP is incredibly arbitrary for several reasons:

    - It rises naturally as a result of Baumol's Cost Disease. That's why it's so hard to reduce.

    - Subsisidies and tax breaks can have the same effect on the economy but different effects on spending as % of GDP

    - It also tells you nothing about how intrusive the government is. Spending is low in Australia but they have incredibly intrusive government wrt civil liberties, as well as strict planning laws and tighter regulations in general than the UK or US.

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  2. Daniel,

    "...and I think constitutional restraint of government, decentralization of power, and democratic decision making are essential."

    Yet it is easy enough to point out that all of these (and in particular the first and the last) are in direct conflict with one another. Democratic decision making, in other words, is going to rub right up against constitutional restraints, and democratic decision making more often than not tends to erode what happens as far as decision making in the localities (centralization is the more common path of democratic politics). So while they may be essential, they aren't the end of the story by any means.

    "I don't want a large government..."

    What is and is not large government is an eye of the beholder deal.

    "None of that really informs what I think about macroeconomics - in fact it's entirely irrelevant to what I think about macroeconomics - but that philosophy of government in addition to my assessment of macroeconomics are of course going to both inform any sort of policy claim I advocate."

    To use Hume's words:

    "Those who have a propensity to philosophy, will still continue their researches; because they reflect, that, besides the immediate pleasure attending such an occupation, philosophical decisions are nothing but the reflections of common life, methodized and corrected. But they will never be tempted to go beyond common life, so long as they consider the imperfection of those faculties which they employ, their narrow reach, and their inaccurate operations."

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  3. "the level of effective demand is an important determinant of output and employment"

    I would argue that is backwards.

    The starting point is a productive activity, not the wish for something known or unknown. (say, milk or an iPad)

    We could all wish for milk and iPads, and have extremely high demand, but no milk or iPads, and so no output and no employment.

    Some years ago the Dutch government, in an effort to stimulate the next Van Gogh, offered to buy any painting for some amount which was greater than the cost of the canvas and paint. Not surprisingly, there was an explosion of artists who sold crappy paintings to this program. In this case there is indeed demand which drives output and employment.

    I don't want to paint with too broad a brush here, and say that all top down spending ends up buying crappy paintings, but prices over the market clearing price (increased demand) drive unpredictable outcomes.

    I don't disagree that your statement is true, but I think it is a very risky way to drive incremental output and employment.

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  4. "To be a 'Keynesian' all you really need is to think...that when the economy is below full employment, spending of any variety (including government spending, but also investment and consumption spending) can have a multiplier effect on output that is larger than it is during boom years."

    This raises several questions:

    1) Can you name some Keynesians who do *not* advocate increased government spending when the economy is below full employment?

    2) If Keynesians thought the multiplier for government spending was less than 1 even during recessions, would they stop advocating increased government spending during recessions?

    3) We have now just completed a fiscal year with the second-largest deficit ever, at $1.3 trillion. It seems obvious that the national debt (even the phony-accounting national debt, that doesn't include the complete present value of all future spending promises) is soon going to pass 100 percent of GDP. What will Keynesians recommend if that happens, and the economy is still weak?

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  5. 1) Yes, Keynes.

    2) Of course!

    3) Nothing as debt/GDP is incredibly arbitrary. How much we can borrow depends on what the bond markets are saying, and they're looking OK.

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  6. Cahal,

    My questions were to Daniel Kuehn, and I would like to see his answers. But as a follow-up to your comments:

    1) In what situation, when he was alive, did Keynes recommend that the government not spend more when the economy was below full employment?

    2) You say that "Of course!" Keynesians would stop advocating increased government spending during recessions if they thought that the multiplier was less than 1, even during recessions. However, here is an analysis that indicates such a result:

    http://www.volkerwieland.com/docs/CCTW%20Mar%202.pdf

    Are you going call Paul Krugman and tell him, "When the facts change I change my mind.
    What do you do, sir?"

    ;-)

    3) You write that the debt/GDP is "incredibly arbitrary". So you say that Keynesian recommendations won't change if the debt/GDP ratio exceeds 100%. How about 150%? 200%?

    With regard to your comment, "How much we can borrow depends on what the bond markets are saying, and they're looking OK"...do you think they can't change quickly? Or would you recommend simply borrowing as much as possible while the bond markets are "looking OK"...and worry about how much has been borrowed only if or when the bond markets turn bad?

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  7. "...and I think constitutional restraint of government,..."

    In what area do you think that current federal government spending is constrained by the Constitution?

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  8. Mark -
    1. Greg Mankiw has been skeptical, John Taylor certainly, Sims has exhibited skepticism. Of course this all depends on how you define "Keynesian". For some people the definition is "people who support increasing government spending during a recession". If you take the term to be an analytic label, there are many Keynesians who don't.

    2. That seems obvious. I'm sure you'd still see advocacy of some humanitarian spending out of some people (myself included) - but nothing to do with any Keynesian argument and nothing of the same scale.

    3. I'm not sure what would change. The best thing for fixing the deficit and the debt is to grow the economy. I don't see why one would stop advocating growing the economy in a situation where that became more important. You might see more people shift to the position that the Fed ought to credibly commit to more inflation. I think a lot of Keynesians have given up on the Fed or at least figured for a while that Ben was on board so they needed to focus on Congress and the White House. If fiscal policy becomes increasingly unpalatable, you might see a switch back to emphasizing monetary policy, I suppose.

    But Cahal is exactly right - if the bond markets aren't registering any problems, it's hard to see what should change.

    Entitlement reform - I would hope - would get more credit from some of the more liberal Keynesians.

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