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Becker on Over-Hasty Conversion

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"When the facts change, I change my mind," say Keynes.  But how do you explain people who change their minds when faced by facts they should have known all along?  Gary Becker wants to know:
As Posner and others have indicated, there appears to have been a huge conversion of economists toward Keynesian deficit spenders, but the evidence that produced such a "conversion" is not apparent (although maybe most economists were closet Keynesians all along). This is a serious recession, but Romer and Bernstein project a peak unemployment rate without the stimulus of about 9%. The 1981-82 recession had a peak unemployment rate of about 10.5%, but there was no apparent major "conversion" of economists at that time. What is so different about the present recession compared to that one, and to other recessions since then, that would greatly raise the estimated stimulating effects of government spending on various types of goods and services?
I am baffled as Becker.  Can anyone help us out?


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COMMENTS (39 to date)
John V writes:

Maybe it's the internet...somehow.

Maybe there's some effect on the discussion by having so many people communicating every little idea and detail day after day across the web.

B.H. writes:

Just a few remarks.

(1) We did get massive fiscal stimulus in 1981-83. Reagan tax cuts and big military spending rise. That was blamed by Volcker for high interest rates. (So where are the high interest rates now?)

(2) The 1981-82 recession was caused by skyrocketing interest rates as Fed fought inflation, and high oil prices. The Fed eased in late-1982 and 1983, and oil prices fell, and the economy recovered. The 1981-82 was not caused by a bursting bubble.

Fed tightening did not cause the current recession. It has eased massively. The 2001 recession and the 2008-09 recessions were caused by bursting bubbles.

Maybe recessions after burst bubbles need fiscal stimulus. Or maybe when the banking system collapses, monetary policy loses its traction so that fiscal stimulus must be used instead.

Alex J. writes:

Perhaps predictions of doom from Paulson and Bernanke regarding the banking crisis? The public might have gotten spooked more readily than professional economists, but even Arnold Kling said that, unlike P+B, he didn't "know how close the dominoes are standing."

In 81, we had just dealt with a decade of stagflation, so perhaps it was easier to think of Volker's interest rates as desperate measures for desperate time. We've had the great moderation, so possibly we've lost some sense of proportion.

Neal W. writes:

Drugs in the drinking water???

Kent writes:

The answer is not in economics, but in human nature.
When confronted with a problem, there are two methods of resolution:
1. Do something to solve it.
2. Wait or do nothing.
If you are a political oriented person(most economists), it is second nature to do SOMETHING!

Blackadder writes:

In the early 1980s, Reagan was President. Starting next week, Obama will be President. That, I expect, explains most of the difference in reaction.

megapolisomancy writes:

I have never seen such panic in the media and among politicians. It is time for another Higgs book ("Politicians in Panic").

The parallels between selling the bailout and selling the Iraq war are striking. And just like some libertarians fell for that, some libertarians are falling for the bailout arguments as well.

BTW, Anthony de Jasay reviews the role of the media, politicians, and economists in his recent columns about the financial meltdown.

RJ writes:

Kudos to B.H. for pointing out the obvious that there are differences between recessions.
Second, I agree with the conclusion that most economists had keynesian sympathies all along, but the climate before this recession inhibited them from admitting to or expressing these ideas. Now that it has become clear that monetary policy alone could only mildly help, Keynesianism is now a hot topic, which many economists that formerly dogmaticly distrusted, is now being re-examined.

English Professor writes:

Most people want to believe that the government can fix things in the economy. This is a great source of security, whether as a proposition it is true or false. My theory is this: economists have been shaken by their failure to see the financial crisis coming. This has led many of them to ignore (perhaps unconsciously) what they had learned from the analysis of past government interventions. They too are now in the world of "want to believe." This is an unremarkable human reaction--but the problem is that economic policy is now being driven by this delusion.

Jack writes:

Here I'll admit that the ''psychology & economics'' literature is useful: the current recession appears so bad because our ''new'' reference point is so good compared with what used to be our reference point a long time ago. Not sure what the exact term is: framing, maybe?

This is the cynic in me speaking.

When the public rhetoric is more of the "small government" type: emphasis on lowering taxes and reducing spending, many economists with a progressive ideology are not going to spend too much time arguing against it.

Instead, they will sit back and grumble "these people don't know what they're talking about." They will speak about something they see that's a fallacy that is more concrete, just so they can stay in the conversation, but won't go "all in."

Now, that rhetoric is virtually gone. Instead "government needs to step in when the market fails" is the rhetoric of the day. Who do they have to argue with? No one. They can get published in newspapers, magazines, or other places because they are now supporting popular opinion.

That's why they just call anyone who opposes them "ethics-free Republican hacks. If the majority of people agree with you already, why argue? Just call the people you disagree with hacks.

Adam writes:

Where has Becker been? What about Lucas and Prescott? I haven't seen a peep from them in the major media. Krugman, Feldstein, and less Keynesians seem to have a lock on the news channels.

Jim writes:

Michael Kolczynski and Blackadder have it about right. Keynsian fiscal stimulus is ascendant among professional economists because professional economists are as self-interested as anyone else. In the current political climate that means cheering for (or at least acquiescing to) fiscal stimulus for the sake of one's career regardless of the evidence.

Greg Ransom writes:

1. Hayek and Friedman are dead -- the two most powerful anti-Keynesian explainers in history.

2. A majority of economists are Democrats -- and their charismatic leader is a far left advocate of massive government expansion, with a prior history as a socialist and student or Marxism. I.e. they are swept up in the moment.

3. The leader of the Republicans is on board the Keynesian train big time -- and has been for 8 years. The GOP economists have either supported Bush or kept quite.

well, 3 is enough for now.

P. Allen writes:

The current state of Productivity - that's what is different "now" compared to "then" and influencing opinions and actions today.

"Then", at the peak of the productivity deficit (known as stagflation") resources (labor) were expensive relative to their potential output.

"Now", closing in on the peak (around 2018 to be exact) of the productivity surplus, labor is cheap relative to its potential output.

Since trends in productivity determine the allocation of resources in the long run, politicians are reflective of their business constituents who are begging for an increase in economic leverage (lower long-term interest rates) in order to close the output gap to a more "acceptable" range.

By the way, I'm not for bailouts, but I am for atonement to one's mistakes, like the Fed's cavalier approach to a "conundrum" in early 2005. It was this "miss" that signaled the exact point in which monetary policy went from "neutral" to "deleveraging" right when the economy needed that leverage the most.

Bill Woolsey writes:

Discretionary fiscal policy was rejected because
monetary policy was thought better--adequate to the task.

"Money supply rule" monetarism died because M2 velocity began to fluctuate.

There was broad acceptance that the Fed should adjust the money supply so that changes in velocity are offset.

There remained some support for a "rule" but it was for the growth path of nominal income.

Many (maybe most) economists came to accept that using open market operations to adjust the Federal Funds rate was a useful way to cause the money supply to change to offsent changes in velocity so that nominal income grows on target.

The Federal Funds rate is trading very near zero and the T-bils that the Fed has tradtionally bought are also trading with rates very near zero.

Nominal income (and so velocity) appears to be droppinng. The practice of the last couple of decades calls for open market purchases to lower the federal funds rate. But how much lower can you go?

A need to rethink. Familiar monetary policy won't work. And so, something different must be tried. And more support for fiscal policy.

Quantitative easing or allowing deflation are also alternatives. But, there must be a change.

I support quantitative easing.

dWj writes:

I think interest rates at 0 have a significant amount to do with it. A lot of economists see monetary response to business cycles as a better-calibrated, better-timed means of accomplishing the same thing as fiscal policy, and are no longer able to observe monetary easing by way of its conventional metric.

Michael writes:

I would look no further than this post by Robin Hanson,

http://www.overcomingbias.com/2008/11/abstractdistant.html

When devastating recessions are far away it is easy to stay cool and collected realizing that little in fact can be done. Now that it is here, we think very differently about it.

8 writes:

Mr. Hoover met the challenge of the Great Depression by acting quickly and decisively, indeed almost continuously throughout his term of office, putting into effect “the greatest program of offense and defense” against depression ever attempted in America. Bravely he used every modern economic “tool,” every device of progressive and “enlightened” economics, every facet of government planning, to combat the depression. For the first time, laissez-faire was boldly thrown overboard and every governmental weapon thrown into the breach. America had awakened, and was now ready to use the State to the hilt, unhampered by the supposed shibboleths of laissez-faire. President Hoover was a bold and audacious leader in this awakening. By very “progressive” tenet of our day, he should have ended his term a conquering hero; instead he left America in utter and complete ruin—a ruin unprecedented in length and intensity.

Marcus writes:

There is no economic definition of what the term 'depression' means and yet people, including economists, are using the term. I think that, by itself, really suggests a possible answer. Especially when you consider the history of its use.

Before the Great Depression the term 'depression' was used for all economic downturns. After the New Deal, when the economy went south, the term depression was too strong of a word. So they coined the term 'recession'.

Now its popular to blame capitalism for the current downturn and suddenly the word 'depression' is back in vogue.

twv writes:

Faced with a crisis, animals are programmed to fight or flee. Intervention looks like fighting to most people. Doing nothing looks like flight.

In truth, the real fight, for economists, is to maintain ground and recommend patience ("do nothing). So economists who give in to the panicking crowd can have it both ways: They LOOK like fighters to the booboisie, but are really giving in, and being rewarded by their conquerors.

Another factor may be the general character of the time: we are all whiners now. Actually "bucking up" and steeling oneself to a time of trial? No, way! We are going to whine and demand that our pampered conditions of the past continue. This happens in business, government, and certainly amongst academics, who do not exactly live in a culture of moral resolve.

As for Hayek and Friedman being dead . . . so to is W.H. Hutt, not that his wonderful KEYNESIANISM, or his book on Say's Law, had any wide effect. But as criticisms of Keynesianism go, his work was both thorough and fascinating.

Lord writes:

Inflation vs. deflation

Steve Sailer writes:

The prosperity of the 1960s boosted the reputations of Keynesian economists, but the stagflation of the 1970s wrecked them. The prosperity of 1980s and 1990s boosted the reputations of the Chicago School economists, but the events of 2008 wrecked them.

You live by the Dow Jones average, you die by the Dow Jones average.

Greg Ransom writes:

I have to ask Steve what the 80s and 90s had to do with the Chicago School, especially were fiscal and monetary policy are involved.

No body is doing a thing to fix the perverse regulatory and incentives problem involved in the housing,finance and banking industries.

Steve:

"The prosperity of 1980s and 1990s boosted the reputations of the Chicago School economists, but the events of 2008 wrecked them."

Niccolo writes:

I think this might be more political in nature.


Kind of like the political business cycle, but only with sentiment as opposed to real economics.

Jacob Miller writes:

I agree with Niccolo. Maybe even economists can see the trend on what's "cool." Or, perhaps because Keynesians get more press time it is more perception than reality that it is more popular. Either way, I think that within five years the popular theory will have swung in another direction.

Mick writes:

Nicollo, I think you overlook how violently counterintuitive free market doctrine is to human beings.

The instinct of humans to exigency is tyrannical social order and arbitrary action. People in these moments psychologically gravitate to strong willed personalities and decisive actions, regardless of empirical analysis. Telling people that the response to an emergency is to break down authority structures and do nothing runs against the grain of our primate minds.

Thus even though economists may know on some analytical level that Keynesian perscriptions are garbage, the herd instinct may be more powerful (few things more herdlike than academic consensus after all...).

GabbyD writes:

it's because people believe that monetary policy (the go-to option) is ineffective now, so we need to use fiscal policy, which we believe is better than doing nothing in a recessionary environment.

Jacob Oost writes:

The way I understand it, the 79-81 recession was seen as the natural if not necessary outcome of finally fighting inflation, whereas our current recession is (erroneously, and with no real evidence offered) seen as a market failure, thus requiring government stabilization.

Gary Rogers writes:

Could it be that there are so many Keynesians because the theory works? Markets have a way of absorbing unsustainable activity up to the point where sudden recognition leads to a loss in confidence. Consumers respond en masse by holding onto their money leading to the classic deflation that follows a panic. On the other hand, cutting interest rates, increased government spending and tax cuts are all proven ways to encourage consumers to start spending again. This is Keynesian theory in a nutshell and it does work.

The problem with Keynesian theory is that it has side effects. The fact that it tries to control the economy by manipulating demand is problematic in that strong demand is the result of a healthy economy while the opposite is not necessarily true. Manipulating demand is not a good way to create a healthy economy. In fact, manipulating demand creates distortions that will, in the long run, create a less than optimum economy. The most common distortions are to shrink savings and encourage debt. The more savings are depleted and debt is increased, the less able an economy is to withstand the next downturn so stimuli must become increasingly larger to prevent a collapse. In addition, the stimulus programs often create their own distortions to markets. Keynesians will downplay these problems, but if you look at our economy today you see consumers that are tapped out, financial institutions that are overleveraged, huge government debt and increasingly larger stimuli just to keep the house of cards from collapsing. All of these symptoms are very predictable results of stimulus after stimulus over the last half century.

The one thing I wish Keynesians understood is the danger of depleting savings and running up debt. On the spending side everything seems good, as everything is turned toward consumption. Very much like the family that uses credit card debt and home equity loans to maintain their life style, our government has been doing much the same thing only on a larger scale. The problem is that both must end and the recovery side is more painful than the spending side is pleasurable. Now the stakes are so high that the borrowing is done trillions of dollars at a time.

Powerful tools in the wrong hands can be extremely dangerous. Given the apparent level of economic understanding in our universities, I would say that relinquishing control of our economy to the likes of Paul Krugman is like giving a gun to a sixth grader. The tool works but it is dangerous in the wrong hands. Giving that power to politicians is completely unthinkable. So, as I get depressed writing this, I am open to suggestions on how to stop the insanity that is going on. Thanks to the GMU economists for bringing some sanity to the discussions.

Jacob Oost writes:

If by "works" you mean "makes a preferred statistic fall in line with hopes" then yes. If by "works" you mean truly grows the economy and does not simply inflate GDP by making more money change hands through artificially stimulated transactions, then no.

The argument as I understand it goes like this: prices are too sticky to fall to market clearing levels, and if you cut taxes then people will simply save the money instead of spending it, creating a deflationary spiral. Thus, the government needs to boost GDP artificially to prime the pump, restore confidence in the economy, and get it growing again.

I have multiple problems with this. The first problem goes back to before the actual argument begins. What causes these recessions? I argue that so long as the government provides basic law and order and corrects for externalities, market failure will not lead to recessions. It takes either outside influence (9/11, a giant earthquake that destroys a city, locusts, etc.) or ill-advised government intervention (over-regulating industry, monetary instability, monetary crashes, etc.).

Take our current problem. So far I don't see anybody offering a reasonable explanation for what market failure led to the recession, and when I do hear explanations of this or that market failure, they can be traced back to bad regulation. As an aside, anything the government does to make hiring or firing workers more expensive than it ought to be, either with labor boards, licensing, etc., prolongs recessions. I know most economists talk about this, including Larry Summers, so how come they never propose reforms along these lines?

So you have a non-market-caused recession. Let the prices fall. Yes, prices can be sticky in the short run, but in the long-run the government can really screw things up for your grandchildren. I see falling prices everywhere.

As for cutting taxes, they only save it if it's a one-time thing, OR the economy is so volatile that people are afraid to spend or invest it. Which means that the smart thing to do, as far as that individual is concerned, is to save his money. It's perfectly rational as a risk-management technique. Let falling prices restore this fellows confidence in the economy. What WON'T restore his confidence is for every politician to run through the streets screaming "it's all over people! We haven't got a prayer!" like Reverend Lovejoy in the meteor episode.

As for fiscal stimulus, it's just shifting resources around. It doesn't create new wealth. At best it's a lateral move, at worst it's a net loss as the government will doubtless pay more than market prices for things (especially labor, as with fiscal stimuli they want to play up the jobs angle with makework policies). And if fiscal stimulus restores confidence, then explain the Great Depression.

Zubon writes:

Pardon if a previous commenter suggested this; I did not read all 31, and I do not know if this is what Blackadder meant. My first guess is self-interest under changing political conditions.

Academic economists expect to have greater influence under the Obama administration than the Reagan administration. Interventionist policies increase what you can do with that influence, while free market policies diminish it. There is also the common worry that interventionist policies require "the right people" to run them properly. If you and your clan expect to run things, you know that you are the right people. We are the ones we have been waiting for.

Troy Camplin writes:

Last I heard, government spending skyrocketed under Reagan. Tax revenues doubled, but spending tripled. Whether anyone was explicit about their being Keynseans, they certainly were. Jack Kemp, who was one of the economic architects in Congress of Reaganomics admitted to being a Keynsean in regards to deficit spending.

Jacob Oost writes:

That's true, Troy, although IIRC you shouldn't blame defense spending alone for that, as many of Reagan's tax cuts and defense measures had to be "bought" from congress by agreeing to pass expanded social spending. In fact, I believe the increase in social spending outweighed the defense spending.

I guess it's like asking which gallons of water made a ship sink.

MattYoung writes:

Because Tresury bill and bonds are the only thing selling right now. It is not the economists, it is the market that has become Keynesian.


Koz writes:

From my pov this is an easy one, I'm surprised that as conspiracy-minded as most libertarians are, that you didn't see it.

The political foundation of the American welfare state is in greater flux now than it has been for a long time. Let's go back a little bit. The philosophical and practical justification for the New Deal was to save people from complete destitution. As time passed, the welfare state grew but the justification behind it shifted away. Sometime between 1979 and 1993 say, the political establishment almost entirely gave up the idea that the point of spending on social programs is to help the poor.

The American people have adjusted to the idea that the safety net is there is smooth away the rough edges of life in a capitalist economy. (No comment on the underlying truth of that proposition, only that the perception of it is the political foundation of the contemporary American welfare state).

That foundation is getting weaker. People are starting to figure out that what really want out of the economy is the opportunity to earn a living
instead of welfare state protections. The academic and political left-of-center want to protect the welfare state, and Keynesian theories of aggregate demand is the tool for that particular job.

Nobody needed that tool before now because the welfare state was built on political foundations that didn't require it.

MattYoung writes:

Start with an assumption, the recession of the early eighties did not involve a serious government imposed constraint on the economy, hence, it was resolved without resort to Treasury. Then assume right now we have a very serious government imposed constraint on growth.

So, we invest in government because it is the constraining resource.

What do we want government to do, or to quit doing?

Rich writes:

The reason for the conversion is obvious. Keynesian thinking is now in vogue with government, who will happily give out jobs to any economist who tells them what they want to hear. In the early eighties, Reagan and Thatcher were interested in Hayek, even if many outside their cliques were not. So there was some balance between sane economics and Keynesianism. Now the nuts are running the asylum.

Joe Calhoun writes:

Steve Sailer comes close when he says:

The prosperity of the 1960s boosted the reputations of Keynesian economists, but the stagflation of the 1970s wrecked them. The prosperity of 1980s and 1990s boosted the reputations of the Chicago School economists, but the events of 2008 wrecked them.

You live by the Dow Jones average, you die by the Dow Jones average.

But I think he misses a little bit because while the 80s and 90s were certainly about monetary policy, I don't think they were really about the Chicago School.

Economists are embracing Keynesianism because they want to stay relevant. What the last 50 years has proven is that government interventions, whether they be on the fiscal side or the monetary side, have deleterious economic effects. If fiscal policy is ineffective in "taming" the business cycle and monetary policy is equally ineffective, economists lose their seat at the political economy table. They lose influence and power.

Hayek has been proven correct. In a Hayekian world, economists don't have any power. If the true economic answer is to let the market work and do nothing, economists become philosophers. And philosopher is a tough, low paying gig.

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