Is Keynesian Economics Relevant Today?

How many of us still remember John Maynard Keynes? Keynes, also called “1st Baron Keynes,” was a British Economist who lived from 1883 to 1946. He has had a profound influence upon macroeconomics, including the economic policies of various governments.

Keynes believed in applying monetary and fiscal policies to lessen the deleterious effects of both recessions and depressions. Keynes went against the classicists of his time who believed that the free markets provided the answer for economic prosperity, even in times of recession. His approach talked about aggregate demand — buying power — that would lift a country out of recession or depression.

Though I am a fiscal conservative, I do believe that we shouldn’t try to apply economic austerity measures until a recession is in our rear view mirror. Keynes said it far more eloquently than I: “The boom, not the slump, is the right time for austerity.”

Has Keynesian Economics Worked in the Past?

If we consider what happened during the Great Depression, we have a bird’s eye view of economic principles and policies at work. In 1937, our country was making good headway against the depression. Unfortunately, Franklin Delano Roosevelt, the president at the time and economically conservative by nature, somehow became convinced that the way to move the country out of recession even faster would be to drastically cut spending (a truly anti-Keynesian move). It didn’t work, and he prolonged the pain of the recession even longer.

In times of economic recession, it’s easy for some of us to believe that what we should do is to pull ourselves up by our bootstraps and “find a job.” Though elegantly simplistic, it really doesn’t and hasn’t worked that way.

Why Austerity in Times of Recession Hasn’t Worked

Let’s suppose that our government made very deep cuts to spending. That would mean that government projects would be shut down, employees would be put out of work, and government programs that might have been around for years would be cut back or eliminated. Though this might sound like a good idea, what would this do for employment and consumer demand?

One theory is that cutting spending and immediately balancing the budget would increase business confidence, and therefore businesses would be willing to up their production. Sounds good, but in practice, it really doesn’t work that way.

Though cutting spending and balancing the budget might give some companies confidence, what would happen if they upped their production and starting manufacturing more goods simply because they felt confident? One could argue, that their collective work force would temporarily increase, thus giving some push to consumer demand.

One could also argue that there would be such a boost in an already high unemployment rate that the hiring done by some of the businesses wouldn’t go anywhere near to replacing the vast displacement of employees resulting from slashing government budgets. If you thought otherwise, then you might be arguing that it is the responsibility of businesses to blindly hire people in the hopes that demand would increase thereby. It just won’t happen!

Wikiedia’s entry on Keynes reads: “Keynesian economics provided the theoretical underpinning for economic policies undertaken in response to the crisis by Presidents George W. Bush and Barack Obama of the United States, Prime Minister Gordon Brown of the United Kingdom, Prime Minister Kevin Rudd of Australia, and other global leaders.”

It goes on to state: “Keynes is widely considered to be one of the founders of modern macroeconomics, and to be the most influential economist of the 20th century. In 1999, Time magazine included Keynes in their list of the 100 most important and influential people of the 20th century, commenting that: ‘His radical idea that governments should spend money they don’t have may have saved capitalism.'”

When Should Deficit Spending Be Stopped?

Deficit spending — simply spending more money than our government takes in — cannot go on forever. A balanced budget amendment ensuring that some time in the not-to-distant future we stop spending more than what we’re taking in might solve the problem in the long run. However, we all know how difficult it is for our two political parties to come to some kind of a conclusion that will help the country more than it hurts either or both of the parties. That said, I don’t have much hope in a balanced budget amendment.

What then are we to do? We might pass a law that says once unemployment goes below a certain percentage point, there will be no deficit spending in the following year. This might work, though it’s still difficult for me to believe that at this point in our history our political parties could get together on such a task.

Debt Limit Fights – A False Argument

The problem, as I see it, with the debt limit standoff between the two parties is that it is a false argument to begin with. Let me explain. If your family incurred debts that it later thought were too high to maintain, would it call a family meeting and say that no debt over a certain amount would be paid? No, because at that point it would be too late to set a debt limit; the family still has to pay all of its debt incurred unless it wants to consider filing for bankruptcy.

During a governmental fiscal year, Congress passes a budget for a later fiscal year. That’s when the arguments should occur, during budget negotiations. It makes no sense for a bipartisan congress to pass a budget, then later argue that it won’t pay the government’s debt because the budget pushed the debt too high. That argument should occur during budget negotiations and not after the budget has been passed.

Democrats and Republicans both have their economic views. Whatever they are, they should be supported by facts and sound economic theory. In the long run, overspending will seriously hurt this country. In the short run, it may be a temporary way to get us out of this recession. Look to history and the Great Depression to get an idea on what works.

In any event, I remain an optimist for our country and am sure that, somehow, we’ll work it out in the long run. Oops! I just contradicted John Maynard Keynes, who said: “The long run is a misleading guide to current affairs. In the long run we are all dead.”

Good Luck!

Theodore F. di Stefano

Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected]. Follow Theodore F. di Stefano on Twitter.

1 Comment

  • Nice Keynesian revisionist history of the depression… The better model would be Austrian economics which would get rid of the keynesian created bubbles and depression/recessions that follow the bubble bursts.

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