Paul Krugman and Richard Layard have issued what they describe as “A Manifesto for Economic Sense“. It is a Keynesian tract for our times. I read Krugman’s End the Recession Now as my airplane book on the way to the US and my final conclusion was that unless you are a classical economist and drenched in classical thought, you would be hard pressed to know how to counter the arguments Krugman makes. He has turned his views into a “Keynesian Manifesto” which has had a quite astonishing number of economists sign on – more than 5000 on my rough estimate. Anyway, here is the manifesto, and if you would like to sign on yourself, all you need do is click on the link.
A Manifesto for Economic Sense
More than four years after the financial crisis began, the world’s major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.
These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.
The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions – other than Greece – this is false.
Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.
The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but – just like the similar response of debtors in the 1930s – it has proved collectively self-defeating, because one person’s spending is another person’s income. The result of the spending collapse has been an economic depression that has worsened the public debt.
The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that’s exactly what many governments are now doing.
The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn – focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing the dampening effects of private-sector spending cuts.
In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy – while it should do all it can – cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.
How do those who support present policies answer the argument we have just made? They use two quite different arguments in support of their case.
The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.
But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.
Moreover past experience includes no relevant case where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main channels were a currency depreciation against a strong world market, not a current possibility. The lesson of the IMF’s study is clear – budget cuts retard recovery. And that is what is happening now – the countries with the biggest budget cuts have experienced the biggest falls in output.
For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment.
So there is massive evidence against the confidence argument; all the alleged evidence in favor of the doctrine has evaporated on closer examination.
The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side – by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case. Every major sector of our economies is struggling, and every occupation has higher unemployment than usual. So the problem must be a general lack of spending and demand.
In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.
As a result of their mistaken ideas, many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.
Better policies will differ between countries and need detailed debate. But they must be based on a correct analysis of the problem. We therefore urge all economists and others who agree with the broad thrust of this Manifesto to register their agreement at www.manifestoforeconomicsense.org, and to publically argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.
If Keynes is the solution.
Why did the wonders of the 1930s not fix the problem?
The 1950s seemed to have been non-Keynesian.
Only the 1960s newer deal seem to have showed up the non-solution of government.
stackja
30 Jun 12 at 1:41 pm
seems a bit light on evidence that fiscal policy works, and worked in the past.
no explanation of why fiscal policy fell into disuse as a stablisation policy tool? what role did fiscal policy play in the great moderation?
A paper has investigated who changes policy advice when the party holding the White House changes.
See http://econjwatch.org/articles/when-the-white-house-changes-party-do-economists-change-their-tune-on-budget-deficits
1. During the administration of George H.W. Bush, Krugman opposed budget deficits
2. A year later, during the 1992 presidential campaign he changed his tune
3. Beginning in 2003, the year of the Iraq insurgency, Krugman opposed budget deficits strongly and frequently.
4. On the 2006 democratic victory in Congress, Krugman reverted to favouring deficits.
in a nutshell, democrat party deficits are good; republican party deficits are bad.
Jim Rose
30 Jun 12 at 2:22 pm
I know that there is a lot of ruin in a nation, but when will the end game begin? When will things have deteriorated so much that even these true believers will have to say “We were wrong”?
Stephen Williams
30 Jun 12 at 4:45 pm
The end game will begin when a majority of Australians start to value competence above celebrity, which isn’t going to happen anytime soon.
benson
30 Jun 12 at 4:56 pm
I don’t think they are all economists. Probably few are economists. I checked out the website and it just asks for the name of the institution/employer, name, email and comment. These type of things are pretty silly. After all, I could put down the name “Steve Kates” or “Sinclair Davidson”. So you can’t even be sure if they are genuine or whether they are real people.
Samuel J
30 Jun 12 at 5:19 pm
“If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case.”
1. The economy is global. The capacity limit can be anywhere in the world!
2. They are clearly not looking very hard.
2dogs
30 Jun 12 at 6:14 pm
The other factor is
Which opens it up for a lot more people to sign – I mean who is against economic sense? It automatically tars anyone who doesn’t agree with the manifesto as being in favour of economic nonsense or economist stupidity.
Samuel J
30 Jun 12 at 6:48 pm
Perhaps we should have our own manifesto for economic sense?
Samuel J
30 Jun 12 at 6:50 pm
Most US mortgage debt was insured by Fannie Mae and Freddie Mac both of which are government backed organisations. This is not disputed. The money was funnelled into the housing sector and sold into the private sector.
US Government Debt is 16 Trillion with no sign of abating.
One can go on, and on, and on. Too little time, too little blog space.
Mr Krugman et al. are talking out of their collective hat.
Scott
30 Jun 12 at 7:14 pm
The key point reinforcing the Keynsian solution is the recovery from the Great Depression. This is a one-offer but the case agaist Keynes is usually to pretend that the world was recovering anyway or that the solution involved butchering the young workers who otherwise may have been unemployed.
Actually the answer lies within the classical framework. War brought about a massive reduction in real wages, a strong shift to saving (war bonds etc.) considerable diversion of spending to capital good (many of which had a peaceful use once the war ended) and a considerable increase in work to repair factories. Marshall Aid was also significant in easing the transition to the posts 1945 prosperity.
As I wrote in an earlier Cat piece
Alan Moran
30 Jun 12 at 7:38 pm
They won’t Stephen. The more people suffer for their religion the more devout they become!
Anne
30 Jun 12 at 7:44 pm
Milton Friedman summarised Keynes as follows:
As for the more subtle versions of Keynes, Robert Lucas wrote in 1981,
Lucas went on saying that the 1970s were a clear cut an experimental discrimination as macroeconomics is ever likely to see and Friedman and Phelps were right.
HT: http://richmondfed.org/publications/research/economic_quarterly/1997/spring/pdf/friedman.pdf
Jim Rose
30 Jun 12 at 8:55 pm
When will things have deteriorated so much that even these true believers will have to say “We were wrong”?
Well, if Europe is any example we have a long way to go.
John Mc
30 Jun 12 at 9:37 pm
I am very troubled by Richard Layard’s involvement with Krugman on this at the same time his Happiness and Mental Health work is being incorporated into UK and US K-12 education curriculum. That cannot be coincidental. Nor is it coincidental that various UN agencies are now pushing citizen “well-being” as being the primary purpose of national govts and UN agencies.
Here’s a New Scientist link to project and agenda:http://www.newscientist.com/special/how_to_be_happy
Also 2012 was the year the UN started publishing the World Happiness Report. And nef is pushing the Happy Planet Index globally as the global replacement for a GDP emphasis.
Awfully coincidental don’t you think that now Layard and Krugman are joining together for state directed economic spending? That’s always the essence of Keynesianism. The state picks the winners and losers. Sounds better than saying Industrial Policy but it functions the same.
Robin
30 Jun 12 at 11:38 pm
OK. I went looking for an Australian connection to Layard and discovered that the Herald and Lateral Economics are publishing a well-being index. Paper credentialing in education increases well-being according to the index and the state intervening to reduce income inequality boosts well-being.
It’s being used to offset a decline in real economic growth to maintain the future will be bright.
http://www.smh.com.au/opinion/political-news/hope-for-clever-nation-20120608-201hk.html
Robin
1 Jul 12 at 12:05 am
Krugman always – always – speaks of private actors making irrational decisions in spite of wise government counsel, decisions which are eventually exposed as the Money For Nothing get-rich-quick scheming that they are.
And, in Krugman’s World, the exposure generally occurs when those irrational decisions produce their natural consequences of huge losses of value as “bubbles” burst.
Thus, government’s role in economic stalls is limited to seeing its rightful and meager tax revenues slashed as its citizens see their incomes cut because of the irrational decisions of (in this instance) narrow-view private bankers.
The citizenry compounds the harm of the irrational private decisionmaking by irrationally ascribing to government some part of the blame for the actions of these out-of-control irrational private actors. Specifically, the citizenry irrationally refuses to raise government funding during times of economic stall, thus depriving a wise and benevolent government of its ability to counter an irrational loss of confidence through profligate, confidence-boosting Stimulus. (In Krugman’s daydreams, I suspect that the character of Stimulus always wears a cape.)
But Krugman always manages to either forget or ignore that those venal private actors rarely act irrationally. While they may pursue aims and goals not consonant with Krugman’s own visions, they usually act rationally in response to existing conditions.
Just as a planet’s otherwise inexplicable shifting of orbit can usually be explained through the operation of unseen gravitational forces, society’s large-scale private actors who appear to have acted irrationally have generally acted as they did because of the influence of some hitherto unseen force acting upon them.
In our recent bubble-burst, it was the wise and benevolent government itself which manufactured and sustained a huge “bubble” in the valuation of real estate.
Through its incredibly expensive programs seeking to confer a portion of the value of our housing stocks to its own favored constituencies, the government itself caused the otherwise unsupportable and drastic rise in the perceived value of that same stock. Suddenly, once every neer-do-well could qualify for a large home mortgage loan – which the banks would grant only because government was coercing them to do so – demand reached very artificially high levels, as did prices.
Then, one day, someone said “a million dollars for that 2000 square foot home in the desert? I don’t think so”, and, 2000 miles away, Krugman felt it like a spike through a voodoo doll.
You tell us that “unless you are a classical economist and drenched in classical thought, you would be hard pressed to know how to counter the arguments Krugman makes.” This is true, so long as you allow him to rewrite history as he sees fit at each moment. Perhaps by “classical thought”, you mean that overly-strict view of world events which doesn’t allow you to make up facts and rewrite history to your own liking? How do you KNOW that you are poorer today than yesterday? Krugman says you were 18% poorer last year than you are now! Krugman says we are all happier and we live longer under our new wiser and more benevolent masters!
bobby b
1 Jul 12 at 3:31 am
I really dislike propagandists who engage in this sort of sleight-of-mind.
Should I sign in as Minnie Mouse to prove its worth?
Elizabeth (Lizzie) B.
1 Jul 12 at 9:34 am
Alan Moran, but what is the Australian evidence on fiscal policy and the recovery from the great depression?
The Treasury view prevailed in Australian and New Zealand fiscal policies from 1931 onwards when their unemployment rates was 25% and more.
By the mid-1930s, their unemployment rates were in mid-to-high single digits.
In Australia, the massive fiscal contraction from late 1930 onwards was called the Premiers’ Plan.
The premiers’ plan required the federal and state governments to cut spending including wages and pensions by 20%. It was accompanied by tax increases. The premiers’ plan complemented the Arbitration Court’s 10 per cent nominal wage cut in January 1931 and the devaluation of the Australian pound.
The New Zealand government also cut everything that could be cut by 20%.
MacLaurin (1936) dated the Australian economic recovery from the last months of 1932. It was three years (1935) before unemployment fell below 10 per cent — the rate it had been during the 1920s.
Australia (and New Zealand) came out of the Depression earlier than most other countries because of the the Premiers’ Plan.
Data published in the 2001 yearbook of the Australian Bureau of Statistics graphed iat http://www.abs.gov.au/AUSSTATS/abs@.nsf/Previousproducts/1301.0Feature%20Article142001?opendocument&tabname=Summary&prodno=1301.0&issue=2001&num=&view= shows a rapid fall in the high twenties unemployment rate in 1932 to be below 10 per cent by 1937.
Australian unemployment was 7.5 per cent in 1938, which is the long-term average for the period 1906 to 1929.
In 1937, the USA was in the Roosevelt depression within in a great depression. The unemployment rate jumped from 14.3% in 1937 to 19.0% in 1938. The U.S. unemployment rate was about 15% in 1940.
Jim Rose
1 Jul 12 at 9:57 am
Good idea Lizzie.
I’ve signed on as Donald da Duck from VRWC Pty Ltd.
Winston Smith
1 Jul 12 at 11:30 am
Maybe its the Minnie Mouses and Donald Ducks of the world that need to say “we were wrong”.
I dont see that happening any time soon enough. The market is way way ahead of them, is speaking, and is not healthy.
Alice
1 Jul 12 at 2:05 pm
There is an excellent series of posts on Keynes on the Market Monetarist blog that explain how and why he came to the fallacious view that fiscal stimulus was the appropriate response to economic contractions.
Sleet mute
1 Jul 12 at 8:02 pm