The Keynesian Proposition


Over at Economist.com, they got Brad DeLong and Luigi Zingales representing Keynesianism and Neoclassical respectively over an online debate on the proposition “We are all Keynesians now.”

The proposition is awkwardly framed, i mean come’on, arguing for the proposition is like arguing that entire political and economic elites agrees over the remedy needed to recover from the current financial crisis, which is an impossible position to defend. This forced DeLong to declare defeat in the opening sentence of his opening remarks. And belatedly, moderator re-frame the debate to be “whether we—or rather, economists and policymakers—should be [Keynesian].” on the third day.

anyway, here is the problem

There are two recession dynamics at work:  (1) plummeting real estate value and consumer spending is discouraging or disabling mortgage payment, leading to piling bad debts that is spreading through the financial sector via securitization and derivatives, banks thus concentrating their capital on deleveraging and not lending to business for expansion. (2) lowering consumer spending is reacted with output contraction and increase unemployment, that further reduces spending and thus the deflationary spiral ensues.

and the Keynesian Proposition

Delong is obviously not against government intervention to get the banks to start landing again or using every possible monetary policy to stimulate the economy. What he is saying that those measures have limits. Monetary tools is already exhausted. and not without politically unacceptable amount of taxpayer’s money can government keep the banks capitalized.

Even with recapitalized banks, in the short-run, under overwhelming uncertainty and pessimism, healthy business that would have invested, will not; innovations that would been commercialize with venture capitalist‘s funding, will not; employed people would have leave their job to start a new spin-off, will not. And there are no guarantee that the money from the recapitalized banks wont just be used to fill another bubble, which is precisely what happen when federal bank pump money in response to the busting of Dot-com bubble in 2000 only to walk straight into a real estate bubble. Therefore, DeLong argues that in the absent of private investment and deteriorating consumer spending , government who can borrow cheaply has to step in to invest and spend.  DeLong also believes that government investment in public goods like infrastructure, basic research, education, broadband access in rural area can create new innovation and business opportunities that fuels economic growth in the future (off setting tax increase needed to pay government debt), and fights deflation now.

the criticism

The fear of fiscal stimulus is that it is hard to execute effectively, because government (by design is slow), wont move quick enough to start projects to deal with short-term problems. By the time government is able to initiate most of its spending, some private business that are ready to invest, will be force to compete with the government for capital (goods, service and labor). Even worst, if in a state of panic, the government is legitimized to pursuit projects that does not have benefit worthy of its cost in order to keep people employed, people will be under an illusion of job security,  and not looking for new job, retrain, or staring new entrepreneurial enterprises.

The other problem of allowing government to allocate resource is that it is often inefficient and it expands politician’s power and attract lobbyist, which by the way is already happening. Obama promised greater transparency to mitigate this problem, but even some Democrat supporter are skeptical.

Furthermore unlike isolated national economic recession, this is a global recession where US government borrowing will have an adverse effect of draining the fund other economies needs for their recovery, subsequently weakens demand for US exports that is crucial for recovery. Unfortunately, global dimension of the recession is noticeably absent from the debate.

to conclude.

If the fear of massive unemployment is that it will lead to social unrest and deflationary spiral, then the government should simply increase and extent unemployment benefit. When people’s livelihood are secure and not occupied by bogus project they will have time to fund jobs, retrain or invent the next growth inducing innovation. Government spending in public goods can be very efficient considering the low cost of everything in a recession. However as Zingales points out these these projects “should be argued on their own merits, not as a stimulus.

So, am i thinking Keynesian? I am not too sure, i mean the label Keynesian is so loaded with different meaning. I am however definitely for unemployment benefit in a recession.

more on this later.

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