Keynesian Economics: Valid Principles or Re-Election Tactics?

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John Maynard Keynes, perhaps the world’s most influential economist. Image by Michael Holroyd, Lytton Strachey: A Critical Biography

Does the employment of Keynesian economics actually spark the economy, or merely help those in office keep their jobs?

Low interest rates: check.

Tax breaks: check

Deficit spending to stimulate the economy: check.

Three primary tools in the Keynesian toolbox, used in significant doses in order to combat economic instability.

For decades, they have been the central tenets utilized by various governments in numerous battles to stabilize the economy, up to and including the recent devastation wrought by the post-2008 financial crisis.

In this latest iteration and via numerous efforts bookended by TARP and QE2, the United States has invested massive dollars into both the private sector and general economic stimulus, simultaneously attempting to snuff out a forest fire with one hand while lighting a match with the other.

According to the National Bureau of Economic Research, the U.S. emerged from the Great Recession in June, 2009, eighteen months after it started — the longest continuous period of contraction and subnormal growth since the Depression of the 1930’s. And yet, despite over $4 trillion in deficit spending since the start of the financial crisis, numerous Gallup polls show fading public confidence in the prospects for economic improvement in the near term. In fact, as of sixteen months ago, 69% believed the U.S. was either in a depression, still in recession or heading toward one.

Does Keynesian economic theory work? First, a summary of its essential underpinnings.

Keynesian Economics: How The Theory Works

Keynesian economics revolves around short-run monetary and fiscal policies and their effects upon aggregate demand. While the private sector is generally efficient in setting supply/demand intersection points, inefficiencies eventually build up due to a myriad of factors that ultimately tip the scales, both positively and negatively. As evidenced by the bubble economies of the 1990’s and 2000’s, the Alan Greenspan-coined term irrational exuberance took hold in both the equities and housing markets, artificially inflating demand. While myriad political and economic forces fueled the excessive demand, the net results were the same in both instances: market collapses which directly led to economic recessions.

Deficit spending, generally the norm, is projected to increase to 100% of GDP in this historic example of Keynesian principles – Image by Farcaster

The past two recessions were certainly noteworthy, but not overly unique in their fundamentals. Nor have governmental responses been atypical. Deficit spending was utilized by President Roosevelt to combat the Great Recession with his New Deal platforms during the mid-1930’s. Although deficit spending has been exceedingly common over the past 70+ years, recessions and wars have further exacerbated federal budget deficits. For the most part, recessionary responses have been nearly identical. In the face of falling governmental revenues due to reduced economic activity, fiscal stimulus in the form of temporarily-reduced taxes and increased public sector spending was undertaken. Coupled with the Federal Reserve’s lowering of short-term interest rates to induce borrowing, these are the quintessential principles of Keynesian theory.

Are Keynes’ Economic Theories Effective?

Many have argued the merits of Keynesian economics since Keynes’ signature work The General Theory of Employment, Interest and Money was first published in 1936. As with any debate, the answer depends upon whom you ask. Forbes magazine’s Timothy Siegel argued that it does work; citing efforts all the way back to Herbert Hoover’s presidency, as well as President Obama’s massive stimulus programs following the collapse of Lehman Brothers. On the other end of the debate, Portugal’s Finance Minister Vitor Gaspar, his nation facing a 14% unemployment rate and years of shrinking economies, said this in 2011:

“We tried stimulus and it backfired. Like some other European countries, Portugal tried ‘a Keynesian style expansion’ in 2008. But it didn’t turn things around, and may have made things worse.”

Based upon the Gallup polls cited above, it appears that despite official reports of a moderately-expanding economy, most Americans would agree with that sentiment.

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