Keynesian Wolves, Life Boats, and Cruises

The Keynesian wolves never get enough chickens. They keep circling the hen house long after their tummies are full. I just read the editorial page of the New York Times (Feb 7). This is not something I normally put myself through but I am on an island and do not have easy access to my usual propaganda. But it is not like the NYT is alone. The President said recently after the good news of the last employment report – “Get it done.” Get it done now. Bernanke chimed in to say this was not the time to upset the markets with worries about high interest rates and fiscal austerity. The clear implication is that we need more fiscal and monetary stimulus.

I have been writing about this unflinching attitude toward stimulus since the beginning of the recession. The biggest problem with monetary and fiscal policy is that it never knows when to end the party – and we end up going from the frying pan to the fire. Ouch. It happens over and over and over. Decade after decade. Century after century.  The wolf goes to Farmer Bernanke and says – you have way too many chickens. Just let me and a couple of my helpful friends inside the fence. Give us a couple of JDs and we promise to take only a few of the older chicks and then we will go back to the woods and leave you alone. I don’t think so.

It seems strange to me is that these Keynesian voices get louder and louder the better the economy performs. How can you explain this? It seems simple to me – that their concern is totally focused on politics. They continue to support an invested ideology of populism that almost guarantees election.

I sound extreme and political myself. But I hope to suggest otherwise. It is sort of like the guy who sells insurance or life rafts to cruise customers. It is easy to make a case for insurance and life rafts before the cruise. There is plenty of uncertainty before the cruise. But does it make sense to sell this stuff after the bloated and sunburned cruisers have completed their journeys and are back on the dock? I think not. 

Under absolutely no measure of any macroeconomic indicator is the US economy in a recession or headed towards one. The boat is back at the dock. It is true that we are frustrated with the improvements in employment. We hear estimates that approximately 15% of the nation’s labor force are without work, without adequate work, or have simply given up. That is too much. The human tragedy is unacceptable. There should not be any debate about this. But there is plenty of evidence that additional Keynesian stimulus at this stage will not quickly improve employment opportunities and that it is possible that a slow and steady recovery in employment is the best that we can hope for.

I have written continuously about the fact that the past recession and our slow growth were the result of a perfect storm of negative economic shocks. This deep hole was worsened by the chickens coming home to roost – too much borrowing and consumption by the private and government sectors for decades and decades finally hit the wall. This is not an easy hole to dig out of. In the very beginning, our policy leaders should have been more forthcoming about this but instead these populists wanted to sell you a life jacket and raise your expectations to unrealistic levels. The reality is clearer today. We see that all those trillions of stimulus we spent could do no more than fill in the bottoms of a few holes and we are left with the residue of perhaps 60 years of excessive spending. We are growing but the path to high employment is slow.

Let me advance one more point about not engaging in more stimulus now. I think we are excessively worried about a double-dip. The economy is stronger than we think. If we don’t want to do the frying pan-fire dance, then we need to let the forces at work play out. These forces will not create a fast remedy for employment but as I argue above, nothing is going to do that anyway. But easing off the accelerator will still leave us going forward at a decent rate. Here is why. Just as the economy was showing some decent growth at the end of 2010 the world got smacked with some new shocks. What happened in 2011 was not the direct result of our inability to escape the recession. It was more the result of earthquakes, tsunamis, and then the recognition of the worsening of the European sovereign debt crisis. It is testament to the underlying flexibility and strength of the US economy that this second round of body blows did not send us back to recession land. It did slow the US but as we begin 2012 we are seeing the dissipation of the residues of the original and then the secondary shocks.

But even better than this end of the shocks is the expected expansionary impacts of the spending multiplier in 2012. Many critics have blasted the Keynesian multiplier when it came to past stimulus. And this criticism was for good reason. Stimulus policies that created negative expectations meant a small multiplier for past stimulus. But macroeconomics also attaches a spending multiplier to non-policy shocks that propel the economy. When, for example, improvements in wealth caused confidence to increase, wealth effects are having multiplier effects. We are already seeing this in 2012 and the confidence effects will continue to build as more good news reinforces more good news. Spending is broadening across many sectors.

Confidence and spending are building in the system. Not only is the US growing but China is doing better and resolutions for the European crisis are more likely. 

This is not the time to top these effects off with more stimulus. There is no quick solution to our employment problems and too much medicine is going to make the patient wobbly. Clearly the risks are present that too much stimulus will do nothing but slow the economy. We saw a quick reminder of this when interest rates started to rise at the end of 2010. Let world growth pick up a little more in 2012 and we will see long-term rates rising and inflation creeping above target values. Rising interest rates will be bad for the recovery and could create dire results for government budgeting.

The economy is on the right path. We might be surprised with the results if we just show a little restraint at this critical time. Resist temptation. Keep those Keynesian wolves at bay.