FROM KEYNES TO OBAMA: FROM A BAD MODEL TO EVEN WORSE POLICY

 

To say that Obama’s administration is taking the country back to Keynesian economics, begs the question: is it possible to de-legitimize Obama’s economic policies by divorcing them from Keynes. I have no time for in-depth research on this point. However, I will outline the line of reasoning that might be useful to those who appreciate the benefits from arguing that Keynes’ model has little to do with Obama’s hit and run economic policies.

Keynes point of departure was that capitalism is not the self-equilibrating system; that is, the well-functioning market that produces and maintains full employment exists only in textbooks. This basic assumption of Keynes’ model has two implications. First, the frequent bouts of unemployment are to be expected. Second, since the system is not self-correcting, full employment policy requires the government to shift the aggregate demand curve to the right.  Those two implications gave birth to government deficit spending. Since deficit spending means that budget balances do not matter, the classical fiscal constitution is gone with the wind.

I conjecture that the primary purpose of deficit spending in Keynes’ model was to boost job creating investments (e.g., roads, bridges, schools), shift the aggregate demand curve to the right and, in the process, employ the unemployed resources (somehow-and miraculously-relative prices of goods and resources were to remain constant). Moreover, he did anticipate that deficit-spending would cease as the economy recovers. Full employment being the sole objective of deficit financed investments, Keynes did not see deficit spending as a vehicle for spreading the wealth around, redistributing income, socializing health care, and promoting various social programs. That is, the desired objectives of Keynes’ and Obama’s deficit spending are different.

Yet, Keynes and Obama have one thing in common. Keynes was in the 1930s and Obama is nowadays more interested in the desired outcomes rather than the costs of getting there. Why and how?

Deficit spending could be financed in two ways: public borrowing and printing money. Both methods of financing deficit spending are costly. The cost of public borrowing is the present value of future tax payments for servicing the borrowed funds. The cost of printing money is inflation. Both Keynes and Obama preferred borrowing to printing money.

According to James Buchanan, a Nobel Laureate, the choice of financing deficit spending by borrowing is a costlier alternative. He wrote: “Within the strict assumptions of the Keynesian model, and in the deficit-demand setting, the opportunity cost of additional government spending is genuinely zero. From this, it follows directly that the creation of money to finance the required deficit involves no net cost; there is no danger of price inflation. …In such a context, any resort to public debt issue, to public borrowing, is a necessary second-best.” (James Buchanan, The Collected Works of James Buchanan, Vol. 8, chapter 3, Indianapolis, Liberty Fund Inc., 2002).

2011-08-24T13:08:31+00:00

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