Debunking Keynesian Economics pt. 1

By Rick Kelo

This is the first in a 10 part article series. Ever wanted to learn more about Keynesian economics?  Ever found it incredibly hard to put your hands on an organized presentation of the beliefs and the errors in Keynesian economics?  Its hard for the lay-person to even nail down what Keynesians actually stand for since that name is used by several opposing ideologies.  There are things Keynes actually said, then things that his acoloytes have later expanded upon and now claim in his name. We will look at both.

In this article series I will give you the theoretical backdrop of Keynesian economics.  I will provide you numerous quotes of precisely what Keynes actually said in “General Theory.”  I will take a couple of the more widely known Keynesian tools like the Philips Curve & the demand for money and demonstrate how following those things to their logical conclusions yields far different policy implications than what they Keynesians use them to justify.

TABLE OF CONTENTS

  1. Introduction (this article)
  2. Philosophical Flaws
  3. Flaws of Stimulus
  4. Technical Flaws: The Phillips Curve & inflation vs. unemployment
  5. Technical Flaws: the Keynesian / fiscal “multiplier”
  6. Technical Flaws: Intro to Interest Rates in the Keynesian System
  7. Technical Flaws: The Demand for Money
  8. Technical Flaws: Job Creation
  9. Flaws of Keynesian Policy in an Expanding Economy
  10. Conclusion: Stupid Things Keynes Believed

INTRODUCTION

Keynes is often dubbed the most influential economist of the 20th century, but not because his ideas are good or because his ideas work – they are neither sound theoretically nor do they work in application.  He is influential only because his ideas are widely adopted.  In the course of disproving Keynesian economics I will also poke some fun at Paul Krugman: Keynes last remaining disciple of any consequence.

STIMULUS IN THE KEYNESIAN SYSTEM

Keynes’ theories center on his belief that government could spend money (fiscal stimulus) and/or create inflation, lower taxes or interest rates (monetary stimulus) to trick the economy into hiring (decreasing unemployment).  His rationale was that those actions would return what Keynes called “Aggregate Demand” back near to the level it had been before the recession.

EXAMPLE: 2009 STIMULUS

On January 8th, 2009 the Congressional Budget Office (CBO) made this dire announcement:

In the absence of any changes in policy…[t]he unemployment rate is forecast to rise above 9 percent by early next year.

RB actual

Romer, Bernstein 2009

President Obama’s economists agreed.  Below is their unemployment projection: So that’s unemployment but let’s now look at GDP… at economic growth.  Below is one figure from that CBO announcement.  I’ve chosen it because it is a common one, and has even made its way into textbooks now as an example of the drop in aggregate demand that results from a recession.  The area in red is what’s called, in Keynesian economics, the “Recessionary Gap.”

This gap Keynesians believe is the difference between the economy we are going to receive and the one we could receive if government filled in the difference with some extra spending.  The Recessionary Gap is the Keynesian call to action:

CBO Jan 8, 2009 Outlook

CBO Budget & Economic Outlook; Jan 8, 2009

The next month America enacted a second stimulus bill for $831B (although the actual spending would later total over $1T).  Ignoring, for the purposes of this example, the future spending which would later be tacked-on the 2009 stimulus (ARRA) brought the total economic stimulus in that time period to almost $4 trillion. 

The rationale was to fill in the gap in aggregate demand and bring the economy back up to its normal, pre-recession level.  Again, you can see above the CBO’s graph which will help make this clear.  So fill this gap in we did!  The combined fiscal & monetary stimulus in 2009 totaled $3.8 trillion dollars!! (see below) (Sources: 1234567)

2009 Economic Stimulus

2009 Economic Stimulus

Now, remember that CBO projection & the Romer Bernstein study quoted above that without stimulus unemployment would rise above 9% in 2010?  Guess what happened WITH stimulus? Unemployment averaged 9.3% for the year.  Now the CBO announcement quoted above really referred to the fact 2010 unemployment would go above 9% unless stimulus was applied.  WITH stimulus the 2010 unemployment ended up at 9.63% for the year. The stimulus had no effect at all on unemployment; we got the same unemployment as was projected without stimulus.

A great many people now mock the Romer/Bernstein study so I have borrowed below one of the many overlays of actual unemployment against their projections:

Actual Unemployment

What about GDP though?  Let’s look again at the CBO projection from 1/8/2009 of what would happen to GDP without stimulus.  You will see it below.  Next to it is a graph of the actual GDP we got with stimulus; the only difference between the graphs was to save time I didn’t inflation adjust every month and just graphed the year end total for each year.

Take a look at the economy we were going to have without Keynesian stimulus on the left side.  Now look on the right side.  Guess what happened WITH stimulus?  In the same way the stimulus failed to reduce unemployment it also failed to improve GDP or fill in the “recessionary gap”.  This is what it looks like to lay eyes on the failure that is Keynesian economics:

Keynesian Comparison

 

SHOW US THE MONEY

Keynes’ theories have been very widely adopted, however, nowhere have they worked:

  • It didn’t work for Roosevelt for the entire 1930s.
  • It didn’t work for Japan in the 1990s.
  • It didn’t work for George Bush in 2007.
  • It didn’t work for Barack Obama in 2008.

There is no instance where the widespread application of Keynesian economics has ever worked. However, all that extra debt caused by government spending does cause long term harm to the economy.  That is why America has yet to experience a recovery.  The only guaranteed effect we have is a higher national debt and lower economic growth.