Saturday, December 11, 2010

Will fiscal policy return to hibernation?

Sometimes the only way to diminish an idea is the try it, to see what happens when it is implemented. Keynesianism was largely irrelevant from the 1970s until George W Bush revived it in his administration, and the Obama administration is crowded with Keynesians. But is this revival supported by the evidence? Michael Boskin said "No" in the Wall Street Journal more than a week ago:
These empirical studies leave many leading economists dubious about the ability of government spending to boost the economy in the short run. Worse, the large long-term costs of debt-financed spending are ignored in most studies of short-run fiscal stimulus and even more so in the political debate.
Only time will tell if we will see Keynesianism again recede. 

One attraction of Keynesian policy is that it lets the government do something and people want the government to do something when there is a problem. There is, however, an asymmetry in how the results are judged. The Obama economists projected a path for unemployment with and without the stimulus program that Congress enacted shortly after Obama became president. Unemployment did not follow the projected path; on the contrary, it has greatly exceeded the path predicted if there were no stimulus. The Keynesians have not acknowledged that this is evidence that their program did not work. Rather they argue it shows that the program was not big enough. They are taken seriously in this response. However, consider what things would look like if the stimulus had not been enacted and unemployment had taken the course that it has taken. Would anyone take seriously the response that the initial shock was bigger than we had realized? Everyone would have concluded that we made a mistake in not passing a stimulus.

There is an incentive for politicians to "do something" in the way the media and the public react to failure. They are more willing to forgive failure or explain it away when the government acts than when the government does not act.

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