Keynes Rides Again

When it comes to jaw-dropping news stories, this week's headliner was surely George W. Bush's final press conference. With his combination of defensiveness, cluelessness, and undiluted arrogance, those 45 minutes were the perfect way for his presidency to end. Still, for my money, the biggest news of the new year so far comes to us from the annual meeting of the American Economic Association. In the NYT's Business section last week, Louis Uchitelle reported that the nation's mainstream economists have suddenly discovered that they do not know what they are doing. More than thirty years of economic theory and research have been exposed as irrelevant (if not dangerous) by the current economic crisis, and the big names in the business are now admitting that they are at a loss.

As Uchitelle put it, "At their last annual meeting, ideas about using public spending as a way to get out of a recession or about government taking a role to enhance a market system were relegated to progressives. The mainstream was skeptical or downright hostile to such suggestions." He could easily have amended that to say: "At their last thirty or more annual meetings . . ." When I was in graduate school in the 80's, it was very clear that any research in the Keynesian tradition -- the school of thought that said that the economy could become stagnant for significant periods of time and could be brought back to health by government spending -- was not welcome. Self-correcting mechanisms were all the rage, with market rationality thought to guarantee that government spending would be either pointless or harmful. Indeed, the only sub-school of thought that adopted the name Keynesian (modified by "New") argued only that business cycles happened for rational reasons in response to unexpected shocks to the economy.

To get some sense of the intellectual environment, consider the following title of an article on fiscal policy: "Is it Sometimes Good to Run Budget Deficits? If so, Should We Admit it (Out Loud)?" I wrote that article just over two years ago for a law review, but even though it was not written for an economics journal, the tone of defensiveness couldn't be clearer. Even to suggest that there were limited situations in which fiscal policy was good for the economy was so alien to the conventional wisdom that it was necessary to soften the blow as much as possible.

Now, we have some of the biggest names in the economics profession saying quite frankly that the seething disrespect for original Keynesian ideas has left the profession at a loss. Alan Auerbach, a prominent economist at Berkeley whose work has included a heavy dose of anti-Keynesian prescriptions for fiscal retrenchment (which I have critiqued here), frankly admitted that "[w]e have spent so many years thinking that discretionary fiscal policy was a bad idea, that we have not figured out the right things to do to cure a recession that is scaring all of us." Uchitelle added (referring to comments by Auerbach): "[A]fter a generation of ignoring public spending in their research, the nation’s mainstream economists lacked the expertise to help guide the process. 'We have not figured out the right course of action,' he said."

That is an astonishing admission, and Auerbach deserves credit for his willingness to speak so frankly on the record. Even more amazing was Martin Feldstein's conversion. Feldstein, a former chief economic advisor to Ronald Reagan, made his academic mark by attacking Keynesian economics, including repeated comments about the "Keynesian fear of saving" and his rather churlish claim that only someone with no children could be a Keynesian economist. (Keynes was childless -- and famously bisexual.) Now, Feldstein says: “While good tax policy can contribute to ending the recession, the heavy lifting will have to be done by increased government spending.”

It would have been much better if we had never had to learn just far off track economists had wandered. As it stands, though, it is very big news that Keynes is back.

-- Posted by Neil H. Buchanan