The Wall Street Journal has a pretty nice discussion of the debate between the proponents of increasing government stimulus spending and its opponents. A few errors or omissions that need clarifying.
WSJ reporter Jon Hilsenrath reports,
The case that government deficit spending can be vital at times of recessions dates to John Maynard Keynes, the British economist whose teachings dominated economics for decades after the Great Depression. "Pyramid-building, earthquakes, even wars may serve to increase wealth," Mr. Keynes said in his 1936 classic, "The General Theory of Employment, Interest and Money."
A counter-revolution led by Milton Friedman, of the University of Chicago, de-emphasized the role of government and gave rise to Ronald Reagan and Britain's Margaret Thatcher. Keynes lost favor during the stagflation of the late 1970s and early 1980s. The Fed and its manipulation of interest rates came to be seen as the best way for governments to manage the short-term ups and downs of the economy.
Actually, the counter debate is not Milton Friedman's, it is Friedrich Hayek's. Also, during the beginning of her administration, Thatcher reportedly held up Hayek's The Road to Serfdom and declared, "This is what we believe," and then slammed the book on the lectern. As great and influential an economist as he was, Thatcher made no reference like that to Milton Friedman.
Even many proponents of more stimulus spending argue that it must be coupled with strong commitment from the President and Congress that the deficit will be cut . . . sometime in the future. Hilsenrath reports,
Carmen Reinhart, a University of Maryland economist who has studied the fiscal aftermath of financial crises, says more stimulus could be counterproductive because it could lead the public to expect even higher taxes in the future.
Instead, policy makers now need to convince the public that they are committed to reducing future deficits, without acting on that commitment right away, she says. That could hold interest rates down, without yanking money from an ailing economy too quickly.
"We are not in an easy position," she says. "Credibility is going to be difficult to achieve."
This is a non-starter - Congress is not credible for three reasons.
First, as argued by Wagner and Buchanan, Keynesian economics simply gives license to politicians to borrow today in order to provide immediate benefits to constituents and favored special interests. That incentive does not change based on any pledge to reduce deficit spending in the future.
Second, no politician can win running on higher taxes and reduced benefits. Therefore, even if politicians today forcefully pledged to reduce the government budget deficit in the future, after this mess is straightened out, future Congresses are not bound by this pledge. In fact, they will readily discover ways to avert abiding by the pledge.
Third, once this immediate problem passes - and it will pass - myopic and shortsighted voters will ignore the pledges made by previous Congresses. There will be no punishment for those who defy any pledges made in the past.
Finally, fiscal stimulus might be effective for reducing cyclical unemployment, but it is likely counterproductive for dealing with structural unemployment. If we are currently witnessing a recession caused by structural changes in the economy, fiscal stimulus spending undermines the recalculation necessary for achieving strong economic growth in the future.
