Bob Cropf

Archive for the ‘Keynesianism’ Category

Did Obama’s team incorrectly diagnose the economic crisis?

In Keynesianism, Obama, stimulus on May 4, 2009 at 1:34 PM

In the April/May issue of the liberal-leaning Washington Monthly, James K. Galbraith writes that the team behind Obama’s economic recovery plans all share the same background and creed (you can find the article online here.). The problem with that, according to Galbraith, is that this leads to severe limitations in their vision of the possibilities of the economy.

Geithner, Summers, Romer, Orszag, et al. all share the underlying belief that the economy will right itself. The chief difference between Obama’s economic team and conservatives, however, is that Obama’s advisers believe that the economy needs a little help from the government to get back whereas economic conservatives assert that such help would actually do more harm than good. Galbraith argues that this could lead to a weak approach to fixing the current mess:

“If recovery is not built into the genes of the system, then the forecast will be too optimistic, and the stimulus based on it will be too small.”

Interesting point: The article claims that the hopes for a quick recovery are based on the assumption that this recession will be no worse than the 1981-82 downturn, the worst in recent history. However, if this is not the case, then the models that have been used to predict a rapid turnaround would be wrong.

If we discard as “normal,” postwar economic experience, then there might not be a near-term recovery at all. A strong argument could be made that the situation we now find ourselves in is vastly different from the postwar economic regime that we are familiar with.

Galbraith argues that Geithner, Summers, et al. are primarily concerned with restoring the pre-crash economic order, which was built on the predominance of private banks. Galbraith quotes the Treasury Secretary, Geithner as telling CNBC:

“We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.”

In the past, economic downturns were shallow enough to permit a bank-led recovery. However, this time things are radically different, according to Galbraith. Millions of families have lost a huge proportion of their wealth. As a dire consequence, for many Americans, Social Security and Medicare represent their chief source of wealth.On top of that, the nation’s largest banks are bankrupt or nearly so. Thus, any attempt to restore the pre-crisis regime is automatically doomed to failure.

The article goes on to say much more. Galbraith is a respected economist, who holds a prestigious chair in Government/Business Relations at LBJ School of Public Affairs, University of Texas at Austin, so he is someone whose words count for something in Washington, DC.

I bring it to the class’ attention because while much of the mainstream media focuses on the conservative attacks on the Obama economic plan, there is also a liberal critique that has not received quite as much attention. Galbraith is a good example of the “loyal opposition” within the left.


Academic economists behind the curve in current situation

In Free-market, Keynesianism on March 5, 2009 at 1:14 PM

Economists from academic departments are behind the curve when it comes to their classroom treatment of the current economic crisis, according to an article in today’s NY Times. Most mainstream economics departments are still in the grips of the free market ideology, despite the failures of said approach to predict the current crisis. More problematic is the near exclusion of Keynesianism as a legitimate object of study in most of the elite graduate economics programs around the country. Keynes is virtually absent from the curricula of economics departments, despite serving as the theoretical underpinnings of the Obama administration’s stimulus package.

The Freakonomics blog also quotes at length a paper that criticizes the economics profession, dominated by neo-classical or free market thinking, with completely missing the current financial mess:

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

According to the last article, the problem with the economics profession is its search for elegance (in model building) at the expense of empirical validation. A large reason for the financial sector’s problems, indeed, is the use of sophisticated mathematical models that had little to do with reality.

Missouri’s stake in the stimulus

In Keynesianism, stimulus on February 28, 2009 at 12:26 PM

What Obama’s Economic Stimulus Package will mean for Missourians

Below is an article, which I just sent off to the St Louis Beacon, an online news publication.

Last month, Congress passed and President Obama signed into law a historic economic stimulus package that will spend $787 billion in the hopes of pulling the US out of the recession. The package has several parts. It will spend $260 billion over ten years to assist families with their taxes, buying a first-time home, paying college tuitions, extension of unemployment benefits and car purchases. More than $80 billion has been set aside to modernize infrastructure including transportation, federal buildings and water projects.Nearly $130 billion will be spent on expanding health care including boosting benefits for laid-off workers and to assist states with their Medicaid payments. Education receives more than $100 billion, with funds set aside for direct payments to local school districts and billions of dollars for school modernization, Pell Grants and special ed programs. The rest of the package is devoted to helping alternative energy production ($22 billion), investments in scientific research ($18 billion) and small business ($54 billion). These are all nationwide totals; what does the package mean for Missouri residents?

A new report issued by the non-partisan Missouri Budget Project estimates that the Economic Recovery Act will primarily help low- and middle-income Missouri families. The report also says the Act will help stimulate the state’s faltering economy.

The Missouri Budget Project’s analysis of the stimulus package has estimated that the state will recieve more than $4.3 billion over the next two years. This amount will be divided into three components: 1) state services, allocated by the Missouri General Assembly, 2) education, a direct transfer to local school districts, and 3) families, a direct subsidy to households hit hardest by the recession. Within each of these components, the spending stacks up this way:

1. State Services (more for health care including a Temporary Increase in the Federal Matching Rate in Medicaid, an increase in highway and public transit funding, more funds for the state to help pay for public safety, law enforcement, services for the elderly and the disabled, as well as money for Child Care services.)
2. Education (growth in spending on Title I, Education Block Grant funds and K-12 and Higher Ed funding)
3. Families (increases in Unemployment Insurance Benefits, funding for Emergency Shelters, and more money for Food Stamps.)

Not only will the billions in anticipated spending directly help Missouri families, the infusion of federal money into the state’s flagging economy will provide a much needed boost. As consumer spending dips, business profits drop off and state government revenues decline, which results in falling demand for goods and services starting the destructive cycle up again. Federal funds will produce a multiplier effect, in other words, for each new dollar invested in the state, a significant amount of new economic activity is expected.

Perhaps the best way to explain the multiplier effect of federal spending is to illustrate with an example. Imagine a currently unemployed construction worker who, as a result of the package’s infrastructure spending, is put back to work on a public transit project. With the wages earned, the worker can make a down payment on a new house, buy groceries and otherwise spend money that would go to stimulating the state’s economy, producing more jobs, more spending and more state revenues.

In sum, the Missouri Budget Project calculates that the multiplier effect will produce a $7.7 billion increase in the Gross State Product, will create 98,000 new jobs, and add $275 million to Missouri’s state revenues over the next two years.

Of course, in a plan of this magnitude there are always skeptics. The chief arguments against the package include more government spending will not end the recession and consumer, not government, spending is the way to get the economy back on track. In the case of the first one, critics assert that much of the government spending in the stimulus package will not have an immediate effect (e.g., infrastructure projects). Therefore, by the time money on these projects is spent, the economic recovery will be well underway. However, this argument assumes the typical long “start-up” times of most capital projects and ignores the fact that in many states there is already a back-log of “shovel ready” infrastructure projects, which have had to be shelved because of the states’ inability to finance them on their own and the recent federal cut-backs in funding. Furthermore, helping to rebuild the nation’s infrastructure, is a long over-due investment in our economic future. Not only does it generate new jobs by the millions, it also ensures economic growth in the years ahead.

The second argument assumes that the multiplier effect for government spending is less than one for privately-generated consumer demand. An example of this can be found in the following blog, Organizations and Markets , by four free-market economists. In a recent post, one of the authors says:

Of course, if GDP is adjusted for quality, the multipler [sic] is most likely negative, as resource allocation is directed by government officials, not consumer demands.

According to this perspective, only the production and consumption of iPods, cars, and similar private goods rather than public goods such as bridges, schools, roads, and libraries, results in “quality adjusted” GDP. Presumably, the author would take issue with Bureau of Economic Analysis of the U.S. Department of Commerce, which estimates additional economic activity that results from investments in different sectors in the $1.58 to $2.08 range. However, as the above quote indicates, free-market economics automatically discounts the possibility that public investments can have a positive effect even before the evidence is in.

It would certainly not be in the best interests of the state if the legislature were to follow the lead of the governors of some states and refuse federal money for some programs. Fortunately, Gov Jay Nixon shows every indication that he wants every federal dollar that the state is entitled to.

Why Keynesianism will (or will not) work

In Free-market, Keynesianism on February 26, 2009 at 1:20 PM

This article is a neo-classical take on Keynes. It presents the rationale behind why Keynes’ theory is supposed to work, which is the multiplier effect. In other words, federal spending for infrastructure and other things will result in additional GDP (an increase in the aggregate demand).

The article’s author does not believe this. He articulates a neo-classical response when he says that

Of course, if GDP is adjusted for quality, the multipler is most likely negative, as resource allocation is directed by government officials, not consumer demands.

I am not sure what he means by “quality” and, maybe if you read the article more closely than I, then something will immediately leap out at you. However, I believe it has to do with “consumer demands.” Again, we are faced with the issue that Galbraith raises, that is, can government produce wealth? Skeptics, such as classical economists, doubt this and so argue that only consumer demand can result in “quality” GDP. Presumably, this increase in aggregate demand would not come as the result of more bridges, roads and other public goods rather than increasing output of televisions and cars (i.e., what consumers want). Hence the author’s logic is that only private consumer goods will produce a true multiplier effect on the economy.