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Keynes Is Passe: Both Parties Say Goodbye To His Stimulus Concept

on 2/22/01.

By James C. Miller III President Nixon once said, "We're all Keynesians now, " meaning that politicians had learned a lot from economists, including John Maynard Keynes. Liberal wags announced the intellectual debate over. Keynes had won, they said. Not so fast. Yes, Lord Keynes was a bright fellow who made important public contributions. He tried to salvage the post-World War I European economies, and he helped to orchestrate the post-World War II Bretton Woods agreement, which contributed enormously to the economic expansion of victors and vanquished alike. But it was his musing about a "general theory of employment, interest and money" that made him a household name. Other economists, especially some in the U.S., embraced his theory, using it to justify a large role for government. To the problem of recession or depression, they answered: Prime the pump, increase government spending. Later, pump-priming took the form of tax cuts, as in the initiative launched by President Kennedy (although it has become increasingly evident that he did this more for what are now called supply-side reasons). The domination of Keynesian fiscal policy reached its zenith during President Johnson's administration, with the ascension of Gardner Ackley to the chairmanship of the Council of Economic Advisers. By then, it was presumed by almost every professional economist that the way to ensure full employment was through demand management, and that the way to accomplish this was through fiscal policy. Monetary policy was presumed to be of little use, and was largely ignored. Then, over the next decade or so, there was an interesting and altogether unexpected development. Researchers, led most importantly by the research shop at the Federal Reserve Bank of St. Louis, began testing the relative effectiveness of fiscal policy vs. monetary policy and found the latter quicker and far more predictable in its effects on aggregate demand. In a rough-and-ready way, this was a debate over monetarism vs. Keynesianism, and monetarism won. The supply-side revolution, which emphasizes the need to maintain low tax rates and small government and pursue stable monetary policies to promote economic growth and maintain full employment, has carried the day. Notice that the Bush tax cut is being supported and opposed primarily as a moral matter. "It's not right for the government to keep so much of your money" - and "No one should have to give the government more than one-third of their income" - are mantras of its proponents. Opponents say it would "cost too much" and that it would "buy a Lexus for the millionaire, but just a muffler for the working person." Because of recent adverse economic news - last month Federal Reserve Chairman Alan Greenspan suggested the economy is probably at a standstill - some argue that an immediate tax cut is needed to stimulate the economy. But note, this debate is not really being framed in Keynesian terms. While Treasury Secretary Paul O'Neill has argued for putting "money into the hands of Americans quickly," this should not be considered evidence of a "revival of Keynesianism," as argued by Washington Post columnist Sebastian Mallaby. The real argument for making the tax cut immediate rests on history: The tax cut must avoid what happened with the Reagan tax cuts in the early 1980s, where the delay in their implementation caused people to shift taxable income to the future, making the recession more acute than it would have been otherwise. Cutting taxes immediately to increase confidence in the future, and thereby promote consumption and new investment, is an argument properly characterized as supply-side. Opponents fall back on their "can't afford" rhetoric. According to New York Times economics columnist Paul Krugman, "claims that tax cuts can be accelerated without reducing our soon-to-be-gone budget surplus are disingenuous." This may or may not be true, but it hardly qualifies as a demand-side argument. No longer is the debate over pump-priming. Gone are proposals for countercyclical spending increases and one-shot injections of consumer purchasing power - such as Sen. George McGovern 's offer to give everyone a cash grant, a notion revived under President Carter by Charles Schultze, then CEA chairman. If this intellectual turnaround seems a little breathtaking, keep in mind that it is breathtaking to professional economists as well. Once the staple of any course in macroeconomics, Keynesianism is now all but abandoned. We should not let deficiencies in Keynes ' general theory and what it spawned blind us to his important contributions. But the idea that made him a household name, "fiscal stimulus," is no longer taken seriously by either political party. James C. Miller III is a former director of the Office of Management and Budget. He is now counselor to Citizens for a Sound Economy Foundation, a market-based public policy organization in Washington, D.C.