Why Does Keynesian Success Feel Like Failure?

The most terrible thing about the bailouts is that they worked.


With Hollywood hipster clothing boutiques declaring "Broke Is the New Black," establishment media outlets circulating the tired phrase new normal to describe America's four-year-old economic stagnation, and producers trying to capture the increasingly fragmented national mood with titles like Downsized and Two Broke Girls, it seems everybody has given up hope for an economic intervention that will bring about the long-promised American Recovery. 

In September a Bloomberg poll found that only 36 percent of Americans approve of President Barack Obama's efforts to create jobs. Around the same time, New York Times reporter Jennifer Steinhauer lamented that some congressional Democrats oppose Obama's $447 billion American Jobs Act "simply for its mental connection to" the 2009 American Recovery and Reinvestment Act. Also in America's newspaper of record, Nobel Laureate Paul Krugman, a prominent voice in favor of Keynesian economic intervention, argued that the 2009 stimulus failed because it was not large enough to close a gap in aggregate demand. 

But the most important goal of the stimulus was achieved almost a year ago: Consumer spending returned to its pre-recession level in the last quarter of 2010. As Robert Higgs, the Independent Institute's senior fellow in political economy and editor of The Independent Review, noted in a blog post this fall, Commerce Department statistics show that the rate of personal consumption expenditures was "continuing to grow" and as of the second quarter of 2011 was "even farther above its pre-recession peak." Real government expenditure for consumption and investment had also snapped back to its pre-recession level and in the second quarter "was running more than 2 percent higher" in real terms, Higgs wrote.

So why aren't Krugman and other Keynesian interventionists cheering? John Maynard Keynes' general theory teaches us that now should be Miller Time. According to the standard macroeconomic model, you revive a stagnant economy by closing the gap in aggregate demand. Taking up the slack in demand is supposed to be the heavy lifting of an economic recovery, the part of the job so big only the government can do it. 

Boosting demand is considered crucial enough that it can justify drafting the young to fight in horrible wars, just to reduce the surplus labor supply. We know this from the standard schoolhouse wisdom that World War II ended the Great Depression (a notion that persists despite having been refuted by, among many others, Christina Romer, former chairwoman of Obama's Council of Economic Advisers). During an amusing CNN exchange with economist Kenneth Rogoff in August, Krugman even argued that if the public could be hoodwinked into increasing inflation and deficit spending to prepare for a hoax invasion by space aliens, "this slump would be over in 18 months." 

With or without E.T.'s help, the recession officially ended more than two years ago, in June 2009, according to the National Bureau of Economic Research. More important, Keynesian "equilibrium" was achieved last Christmas. Demand has been restored. The strengthening of the dollar and a threatened increase in the net saving rate have been, with vast and concerted public effort, averted. Interest rates are low or effectively negative. Deficit spending has more than doubled. 

And yet the economy stays narcotized. Month after month the Bureau of Labor Statistics reports unemployment above 9 percent, higher than it was when the 2009 stimulus became law. Even allowing for the usual lag in post-recession job growth, the employment recovery is by far the most anemic since the end of World War II. At the pace of hiring that has held for the last two years, the jobs lost in the current recession will not be replaced until at least 2018. 

"There's really nothing in Keynesian theory that encompasses indebtedness—consumer indebtedness and corporate indebtedness," Higgs said in a phone interview. "That's why these guys are at sea. This boom was built on heavy leverage. People are looking back, and they're saying, 'We were crazy to go that deeply into debt. We have to change that.'?" 

Higgs points out that while spending is back, investment remains low. The trillions of new dollars that have been created by the Federal Reserve Bank are being absorbed into critically ill balance sheets. "Firms, if they have cash flow, are repaying debt," he says. "If they increase output they're doing it with their existing work force, maybe augmented by new equipment or software."

Higgs and others hold that money is staying in the vaults because of regime uncertainty. The Patient Protection and Affordable Care Act, passed in 2010, has created a new panoply of expenses for anybody looking to hire an employee, but the full range and nature of those expenses can't be measured even by a team of lawyers. The Fed's battery of fanciful tools—including paying banks interest on reserves and conducting rounds of quantitative easing by buying long-term debt while selling short-term debt—makes it even more difficult for nonpolitical figures to understand what the future holds. 

The seemingly simple solution to this problem—and my personal advice to anybody looking to sell a house or get a job—is to lower your asking price. But University of Georgia economist George Selgin, author of the deflation classic Less Than Zero, says letting wages and prices go where they want to go—namely, down—is not the solution. "I have defended deflation," Selgin said in an interview, "but only if it's driven by productivity gains." He noted that the demand collapse occurred "in 2008 and 2009, when the Fed should have provided liquidity but was too busy bailing out its Wall Street buddies."

"Demand-driven deflation is a very bumpy road," Selgin continued. "Prices and wages are rigid downward. Today there are lots of rigidities in markets that aren't going to come down easily. So that means any poor sucker who does his share and takes his cuts is going to be living less well and waiting for everybody else to take their cuts." 

Still, a market-clearing deflation could be less painful than four years (and counting) of stagnation—less painful for everybody except Keynesians, who only know how to make prices go up, not down. On the evidence of the last few years, it's not clear that they even know how to make prices go up anymore. But that may not matter, because the Keynesians are still in charge of everything. How do you like their new normal? 

Tim Cavanaugh is a senior editor at reason.