David R. Henderson  

The Keynesian Model is not a Big Government or Small Government Model

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The Keynesian model is not a "... Lip Service...

Co-blogger Scott Sumner has written an excellent post this morning pointing out that the Keynesian model per se is not a big government model. He is right, for the reasons he gives.

When the late Ben Rogge came to give a talk at the University of Winnipeg in the winter of 1969, I asked him if there were any non-big-government Keynesians. He named one: David McCord Wright. Isn't it striking that he named one rather than saying, "Oh, yes, there are a lot of them."

Then, when I first learned the Keynesian model later that year in my one undergraduate course at the University of Winnipeg, I came to the same conclusion as Scott: If the government raises taxes during booms and lowers them during busts, or decreases government spending during booms and increases government spending during busts, there is no built-in growth of government from following the policy implications of the Keynesian model. Nevertheless, even then I noticed that the Keynesians who wrote my textbook--Paul Samuelson and Canadian economist Anthony Scott--seemed to be big-government people. When I started looking around, I noticed that most Keynesians were big-government people.

Why was that? I think it was because they were big-government people anyway and they could use the Keynesian model, quite consistently with no sleight-of-hand, to advocate tax increases during booms and government spending increases during busts. I hasten to add that I'm not accusing them of any kind of dishonesty. They honestly believed in big government and, with that belief, it came naturally to them to advocate as they did.

Scott writes:

If you could convince me that it [the Keynesian model] worked in a technical sense, I'd immediately favor tax cuts in recessions and tax increases in booms.

My bottom line would be different from Scott's and it's informed by something Alan Reynolds told me in the mid-1970s:
If you could convince me that it worked in a technical sense, I'd immediately favor tax cuts in recessions and cuts in government spending in booms.

Alan pointed out that that would lead to a small-government bias in Keynesian policy.


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CATEGORIES: Fiscal Policy




COMMENTS (21 to date)
Daniel Kuehn writes:

There might be some ambiguity here in what counts as "Keynesian" and what counts as "big government". Greg Mankiw and John Taylor come to mind immediately as (New) Keynesians that don't really support big government. Given how iconic those two are I'm sure there's plenty of people I don't know out there that fit basic Mankiw or Taylor sensibilities in their politics. I don't think of myself as supporting big government though I guess I don't think of myself as supporting small government either.

It seems to me the major growth in government in the postwar period (and really for all of the twentieth century) didn't have much at all to do with macro stabilization. Now you're right even if it doesn't need it it could still be justified on the basis of macro stabilization, but that would, I think, come across as a pretty convoluted argument and there are much better justifications for it available which is why I don't think you see anyone using Keynesianism as a justification.

Andrew_FL writes:
Alan pointed out that that would lead to a small-government bias in Keynesian policy.

But the bias toward big government in Keynesian policy comes from the self serving way politicians implement it, why wouldn't they do the same with your version?

Andrew_FL writes:

@Daniel Kuehn-Regarding John Taylor, he uses New Keynesian models but has also accepted being labeled an "Anti-Keynesian."

Since I have long been critical of the use of discretionary policy in this way, I think the Economist is correct so say that I am anti-Keynesian in this sense of the word. Indeed, the models that I have built support the use of policy rules, such as the Taylor rule for monetary policy or the automatic stabilizers for fiscal policy, which are the polar opposite of Keynesian discretion.

As you say, it depends on what one means by "Keynesian"!

David R. Henderson writes:

@Andrew_FL,
But the bias toward big government in Keynesian policy comes from the self serving way politicians implement it, why wouldn't they do the same with your version?
You’re right that they have that self-serving bias. How could they do that with my version?

Andrew_FL writes:

@David R. Henderson-off the top of my head they could use tax cuts as cover for making the code more progressive and complex, for example by emphasizing "middle class tax cuts" and they could shift more spending into "automatic" programs so they can say they are cutting "discretionary" spending during booms.

Daniel Kuehn writes:

Andrew_FL -
Yep, that's the ambiguity. And of course most Keynesians wouldn't think of themselves as being discretionary they think of themselves as rule-based (indeed in the realm of monetary policy a Taylor Rule!).

ThaomasH writes:

If one follows the rule of investing according to an NPV rule, one gets anti-cyclical spending that looks "Keynesian"

Jason S. writes:

I think there's a different reason for the correlation between Keynesianism and big-government support. The motivating theoretical assumptions of Keynesian macro have to do with market failure: sticky wages and prices and liquidity traps. Markets don't heal themselves and need management. That view appeals to those generally skeptical of markets.

Also, a really small government simply wouldn't have the capacity to do fiscal aggregate demand management. Imagine the federal government were as small as that in 1900, spending and taxing about 3% of GDP. Abolishing all federal taxes would only be a fiscal stimulus of 3% of GDP. Increasing government spending by only 3% of GDP would double the spending-revenue ratio and raise the possibility of default.

David R. Henderson writes:

@Jaason S.,
Also, a really small government simply wouldn't have the capacity to do fiscal aggregate demand management. Imagine the federal government were as small as that in 1900, spending and taxing about 3% of GDP.
That’s a problem I would love to have.

Andrew_FL writes:

@David R. Henderson-As would I, but 3% is the figure for 1900 for the Federal government. With state and local it's almost 8%.

ThaomasH writes:

What really is “Keynesianism?”

1. Is it the belief that government taxes and expenditures should not be determined by debt or any of its time derivatives?

2. Is it the belief that tax and expenditures should be guided by cost benefit analyses that take account of both the borrowing rate and differences between marginal costs/benefits and market prices for the costs and benefits going into the NPV analysis when those differences are the result of unemployed resources?

3. Is it the belief that sudden changes in private sector assessments of future income or the probability distribution that they assign to those future states -- "animal spirits" (and not only monetary shocks) can create inadequate aggregate demand (that will not be swiftly be eliminated by changes in the prices of goods, services and wages)?

4. Is it the belief that central banks cannot (or will not) maintain trend growth of NGDP (and that government has to go beyond taxing and spending dictated by points 1 and 2 above )?

Or is it something else?

Bob Gillette writes:

Am I right in assuming that in the following passage:


"If the government raises taxes during booms and lowers them during busts, or decreases government spending during booms and reduces government spending during busts, there is no built-in growth of government from following the policy implications of the Keynesian model."

that the "reduces government spending during busts" should read "increases government spending during busts"?

That would be my understanding of a counter-cyclical policy.

Greg G writes:

ThomasH

>---"What really is “Keynesianism?”

You will get a lot of different answers to that. Some people will focus more on what people claiming themselves to be Keynesians have advocated. Others will focus more on what the man himself actually said.

I favor the latter approach. Keynesianism is the belief that a counter-cyclical fiscal policy is best...assuming of course that Keynes himself was a Keynesian.

David R. Henderson writes:

@Bob Gillette,
Good catch. Thanks. Correction made.

Mr. Econotarian writes:

Keynesians might argue that the "multiplier" is higher for specific types of fiscal stimulus - Auerbach and Gorodnichenko (http://www.nber.org/papers/w16311) find that military spending has the largest multiplier.

ThaomasH writes:

@ Greg G.

Ah, but then, what is "counter-cyclical?? and what is "policy?" :)

Does "policy" mean departing from an NPV rule? When? Or does it mean modifying the NPV to account for differences between market prices and marginal costs/revenues?

ThaomasH writes:

@ Andrew FL

Interesting quote from Taylor.

I wonder if in his book a NPV rule modified using marginal costs/revenues as inputs would count as an "automatic stabilizer?" What about automatic elimination of wage taxes when in a "recession" somehow defined?

Is the opposition to "discretion" that it leads to too large a deficit or that the circumstances of exercising "discretion" are not conducive to good decisions about changes to taxes and spending?

Greg G writes:

ThaomasH,

I see your point. These are good questions.

My own sense is that Keynes was ultimately more worried about unemployment than anything else. But of course that raises the question of how much unemployment is too much.

Andrew_FL writes:

@ThaomasH-My understanding is that the "automatic stabilizers" are: progressive income taxes, that automatically contract revenue in absolute terms and as a percentage of GDP when the spending stream contracts, and certain transfer payments programs like unemployment benefits that automatically increase outlays when people are out of work.

I don't think the first is a good thing worth any stabilizing effect it has and I don't think the latter stabilizes at all, quite the opposite.

As for your investment hobby horse, Taylor critiqued the stimulus on the grounds that little of it actually went into making government purchases.

The most striking finding of that data is that only .04 percent of GDP in the large $862 billion package went to federal infrastructure spending, and the large amounts of funds sent to the states for infrastructure spending have not resulted in an increase in infrastructure spending. Raul Labrador of Idaho asked me if the stimulus package would have worked better if there had been more infrastructure spending, but the lesson is that it’s not really feasible to start large government infrastructure projects in a timely enough manner to affect the economy in a recession. There is no such thing as “shovel ready.” In my view we learned that from the 1970s stimulus packages, and indeed it is part of the reason that many of us teach in elementary economics that such discretionary stimulus packages are ineffective.

In other words, Taylor doesn't think your NPV idea is even feasible to implement, without even getting into its fundamental misconceptions. I really think you have a kind of naïve belief about what government can do, typical of someone whose too much of an "optimizer."

michael pettengill writes:
If you could convince me that it [the Keynesian model] worked in a technical sense, I'd immediately favor tax cuts in recessions and tax increases in booms.

I'm pretty sure Keynes would reject that policy as stupid and totally missing the point.

How can that kind of policy effect Keynes most emphatic prescription:

I feel sure that the demand for capital is strictly limited in the sense that it would not be difficult to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure. This would not mean that the use of capital instruments would cost almost nothing, but only that the return from them would have to cover little more than their exhaustion by wastage and obsolescence together with some margin to cover risk and the exercise of skill and judgment. In short, the aggregate return from durable goods in the course of their life would, as in the case of short-lived goods, just cover their labour costs of production plus an allowance for risk and the costs of skill and supervision.

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.

I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution.

Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omne (who are certainly so fond of their craft that their labour could be obtained much cheaper than at present), to be harnessed to the service of the community on reasonable terms of reward.

The high tax rates and numerous tax dodges that Milton Friedman criticized were pretty good tax policies to accomplish what Keynes advocates to harness "the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omne" for the good of the community.

Tax dodging has generally required significant employment of labor in excess of the taxes dodged. For example, to dodge a 50% corporate tax, you must pay 50% of the labor cost to build productive capital like R&D, machines, new employee training to get the immediate deduction of expense, instead of waiting to depreciate the capital to deduct the cost of capital.

Milton Friedman criticized the tax policies of high tax rates and lots of tax dodges as promoting hiring too many workers, paying too much in labor costs, and investing too much in capital, especially in the excessive drill baby drill that led to the 1970 peak oil production in the US, followed by decades of decline (until Obamanomics tricked investors into destructive investment in drill baby drill that euthanized the rentier, monopolist, and functionless investor, and doomed the coal industry).

Keynes would love a carbon tax that was set to rise fairly rapidly over two decades because it would euthanize the pillage and plunderers of capital with high tax and promote so much investment in capital that the rentier et al would be euthanzied, without raising much if any tax revenue. And as Trump would say, "there would be so much employment and so much consumer spending, you would be begging for unemployment so you can spend time watching TV in your solar house and drive around in your electric car and drive into the mountains to see the clear blue sky and the forest of gorgeous wind turbines offshore."

michael pettengill writes:

ThaomasH writes:

If one follows the rule of investing according to an NPV rule, one gets anti-cyclical spending that looks "Keynesian"

Are you saying you pay labor to build productive capital according to the NPV rule?

If yes, you get at what Keynes advocated - the higher the profits from rents and monopoly, the more paid to labor to build productive capital to euthanize the rentier and monopolist.

If you mean the more you work to inflate old asset prices driving the managers to slash labor cost for building productive capital and for operations to increase rents and monopoly profits, then, no, that is exactly the Paradox of thrift (not Keynes) which Keynes was countering by his policy advocacy.

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