Saturday, June 23, 2012

What Keynes Said and What Bush Did

What did Keynes really say? He argued that governments able to run deficits, because they can print money, should run deficits in weak economic times - and run surpluses in good economic times.

What Bush 43 did was run deficits in good (low unemployment) economic times. By putting the winter woodpile in the stove in late summer, he stirred up the anti-deficit forces so that Obama had a hard time getting enough wood together for the stimulus he needed after the crisis of 2008.

This is the central message Paul Krugman has been hammering home in his New York Times column for months or years and in his excellent piece with his wife Robin Wells in the latest July 12 New York Review of Books. The NYRB article reviews the relative roles of Larry Summers, CEA Chair Christina Romer, Timothy Geithner et al. in the Bush 43 response to the financial crises of 2008 and then the Obama response to the spreading economic crisis of 2009.


The "starve the beast" thesis of the Reagan era (cut taxes and create a deficit crisis that will inhibit spending) turned the United States from the largest creditor nation in the world to the largest debtor nation. Under Bush 41 and 43, the Federal Government continued to run deficits even through unemployment was very low by historical standards. Only Bill Clinton, during the Democratic interregnum, ran surpluses. I commented on this in September 2008.

At precisely the point where all the anti-deficit armory was assembled, the financial crisis hit and its size and psychological impact had a huge economic impact on the U.S. and world economy. Just as the anti-deficit forces went to work, the need for stimulative spending suddenly became acute. As Krugman has argued at length, Obama's response fell short because of growing GOP opposition in the Congress. One reason is that state and local government revenues fell with the economic decline (they can't print money) and this offset the national stimulus. So states and localities have been faced with huge deficits in FY09-FY11 and more deficits face most of them in FY12 and FY 13, with no stimulus money left to help.

Now Steve Malanga of the Manhattan Institute castigates states and localities for spending too much in good times and not putting away money for bad times. He quotes Keynes. He tells us he asked then-Mayor Koch to put money into a rainy-day fund. Koch correctly responded that elected officials find this difficult to do. So far, rainy-day funds tend to be spent at the first hint of dewfall.

Here are my comments:
1. Keynes was focused on the national level.  Counter-cyclical fiscal and monetary policy is meant to be applied at the money-printing level. States and localities just don't have that power. When Greece and Spain gave up the drachma and peseta, they gave up their ability to pursue a counter-cyclical policy for very long - that power has gone to the European Union and the European Central Bank.
2. States and localities have to balance their budgets.  Balanced budgets are the law in many states and it's reality in the rest of them. When states and localities talk about deficits they are talking about gaps that must be faced. These gaps must be closed through borrowing or other gap-closing measures.
3. Some counter-cyclical mechanisms work well. Revenue-sharing with states and localities was a good idea. New York City's averaging of assessed values over five years is a hugely successful mechanism that evens out property-tax revenues over the business  cycle.    

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