Wow! One data point [World War II] and you’re jumping for joy. The last time I checked, wars only destroy!
This poetic passage from “Fight of the Century,” a new economics hip-hop music video that kicked off an opening session of the Investment Management Consultants Association, held in New York City in January, encapsulated a key argument of one the session’s two presenters: that claims as to the effectiveness of expansionary fiscal policies to counteract a downturn—as happened during the Second World War following the Great Depression—are without merit. I beg to differ.
And I’m in good company. The idea that fiscal policy can be used to moderate booms and busts in the business cycle gained currency when British economist John Maynard Keynes published his “General Theory of Employment, Interest and Money,” in 1936. The central tenet of his treatise—that aggregate demand, rather than supply, guides economic activity—became a guiding principal of economic policy among Western governments in the post-war years.
At the IMCA conference, Jared Bernstein, an economist for the Washington, D.C., Center on Budget and Policy Priorities, represented the Keynesian side of debate portrayed in the music video. Increased government expenditures, he said, should be used to compensate for economic contractions caused by reduced consumer spending and business investment during a recession. That increased spending, he said, has a “multiplier effect:” the initial change to aggregate demand causes aggregate output (and national income) to increase by a multiple of the initial change.
To buttress his case for Keynesian economics, Bernstein displayed PowerPoint slides showing the impact to the economy of the Obama Administration’s $787 American Recovery and Reinvestment Act of 2009. Soon after the stimulus package’s enactment, he noted, GDP contraction slowed, reversing the negative 9% annual growth rate posted in the fourth quarter of 2008. By the second half of 2009, the economy was expanding again.
Only after stimulus spending petered out in late 2010 did GDP growth begin to slow once more. The stimulus package, he said, wasn’t large enough to overcome the economic devastation wrought by the bursting of a housing bubble that resulted in trillions of dollars of lost wealth. A spending bill closer to $2 trillion, a figure supported by Bernstein and many other economists, would have been needed to maintain the desired level of growth.
Bernstein cemented his case for a Keynesian stimulus program with two additional visuals: one showing consumer spending falling by a smaller than expected amount (given the lost household wealth) after the Recovery Act’s passage, followed by an uptick in spending; and a second showing the Congressional Budget Office’s projected unemployment rate in January 2012 (11%) minus the stimulus; and actual rate (8.5%) with the stimulus.
Case closed? Russell Roberts, the session’s second speaker, wasn’t buying it. A professor of economics at George Mason University in Fairfax, Va., Roberts represented Keynes’ opponent in the music video: Friedrich August von Hayek, an economist and philosopher best known for his defense of classical liberalism and free-market, laissez-faire capitalism.
Roberts questioned whether economists can gauge the impact of government spending in a “useful and measurable way.” In respect to the CBO projection cited by Bernstein, for example, Roberts observed the estimate pegged the number of jobs to be created by the 2009 stimulus package at between 400,000 and 2.4 million—a six-fold difference that renders the determining of cause and effect an exercise in imprecision.
More troublesome, said Roberts, is economists’ inability to isolate the effect of a change in fiscal policy from other variables impacting the economy. To do so scientifically, he added, would require the impossible: observing two parallel economies, one with the change and, all else being equal, one without. Thus, Russell concluded, projections like the CBO’s rely on “fake science” and cannot be taken seriously.
Underpinning Roberts’ skepticism about Keynesianism is the belief that expansionary fiscal policies can do as much harm as good. When, for example, the government spends more money on steel and concrete to build out infrastructure (or, as during World War II, ships, aircraft and tanks), the funds channel limited resources into projects that could otherwise be used—potentially more efficiently—by the private sector.
Roberts makes valid points. Certainly economics is, if not a fake science, then an inexact one. But I reject his view that fiscal policy, in so far as pitting the public against the private sector, is a zero-sum proposition.
As Bernstein noted, the federal government has a constructive role to play precisely when consumption and investment—not to mention outlays by cash-strapped state are local governments—are in free-fall. How can the federal government be competing for scarce resources when consumers and businesses, whether out of fear or other reasons, are hoarding cash?
Bernstein was right: The best economy is a hybrid, one that leverages fiscal tools to moderate the economy’s cyclical peaks and valleys, stabilize markets and generate economic growth through appropriate financial incentives. All of which, I think, is worth rapping—or rhapsodizing—about.