Obama Gives Keynes His First Real-World Test British economist John Maynard Keynes believed government spending could pull an economy out of recession. After deficits ballooned in the 1970s, his ideas were widely discredited. Now, with the Obama administration's $825 billion stimulus plan, Keynesian economics gets its first real-world test.
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Obama Gives Keynes His First Real-World Test

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Obama Gives Keynes His First Real-World Test

Obama Gives Keynes His First Real-World Test

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From NPR News, this is All Things Considered. I'm Michele Norris.


And I'm Robert Siegel. John Maynard Keynes has been in the news a lot lately. He is the economist whose work inspired President Obama's plan to save the U.S. economy. Keynes is an unlikely hero for our time. He died more than 60 years ago and for years his ideas appeared to be discredited. As part of an ongoing collaboration, This American Life producer Alex Blumberg and NPR's Adam Davidson explain why Keynes is back.

ALEX BLUMBERG: Keynes published big theory, the theory underpinning President Obama's fiscal stimulus in 1936. And many would argue that 73-year-old theory is being tested right now for the very first time. And Adam, you've been carrying around Keynes' thousand page biography for weeks now getting ready for the story.

ADAM DAVIDSON: Yeah, it's the abridged version by the way. It's by this guy Lord Robert Skidelsky. It is a great read because Keynes is a totally fascinating character. Every few pages, I'm switching between thinking he's an amazing, charming, genius, and thinking he's a narrow-minded jerk. He raw with the Bloomsbury group, you know like Virginia Wolf and all those painters and poets. They were all into free love and raunchy language, and they used to complain in letters to each other that Keynes was just way too dirty for them.

BLUMBERG: He loved hurling himself on the public stage with some outrageous shocking opinion. And he was really all over the place. Sometimes he's almost a socialist, then he's fanatically defending free markets.

DAVIDSON: But there is a common thread.

BLUMBERG: A thread of elitism.

DAVIDSON: Yeah, elitism. Exactly. He generally felt that almost any problem could be solved by getting together a bunch of young men who had gone to Cambridge and asking them to run things. Every once in a while, he might be OK with an Oxford man but really Cambridge was best. He even wanted Cambridge men to run America. He didn't think anyone in the U.S. was smart enough. He also didn't like Jews, the French, the working class...

BLUMBERG: And he wrote that these Cambridge-led government boards should do everything from running individual companies to determining how many babies should be born. And he wrote cryptically, of what quality. He was after all on the board of the British Eugenics Society.

DAVIDSON: So here we are in modern day America, millions of working men and women in peril and this is the guy we're turning to? A bigoted Americaphobe who hates working men and women?

BLUMBERG: The short answer is, yes. And it's all because of this book he wrote in the 1930s - his prescription for how to get out of a global depression. It was his masterpiece published in 1936, "The General Theory of Employment, Interest, and Money."

TYLER COWEN: I've read the general theory five times I would guess. I think the first time I read it, I was maybe 18.

BLUMBERG: Tyler Cowen is an economist at George Mason University. And he's very publicly reading Keynes' masterwork again, this time writing notes and conducting a discussion on his blog, Marginal Revolution.

DAVIDSON: Cowen says in the general theory, Keynes corrected what he saw as a fundamental error in the economics that had come before. Under classical economics, if there's a downturn, the economy will sort itself out. If people aren't buying enough, prices will drop to where people start spending.

BLUMBERG: Keynes' radical insight was to look out the window in the 1930s and see that sometimes things don't right themselves.

DAVIDSON: And the economy goes into a downward spiral. Everything just gets worse and worse. And it looked in the 1930s as if that's what was happening and to some extent, it was.

ALAN BLINDER: A failure of effective demand he called it.

BLUMBERG: This is another economist, Alan Blinder at Princeton, who was an economic adviser to President Clinton. A failure of effective demand he says is basically that people aren't spending enough money, either because they don't have any or because they got laid off or are afraid they're about to get laid off.

DAVIDSON: And if people aren't spending enough money, there's no way for the economy to automatically adjust. And in the 1930s, nobody else had figured out how to get people spending again.

BLINDER: The Keynesian prescription is if all else fails, the government can spend the money. So normally, we don't say in a free-market economy, well the government, we say well, people in businesses should do it. But Keynes' idea, which was revolutionary at the time, is if the private sector won't do it, then the public sector can do it as a fill-in stopgap.

BLUMBERG: Alan Blinder, the Keynsenian economist at Princeton, says that there was a triumphant sense among Keynesians that by carefully tweaking taxes and spending, government could overcome booms and busts. Master the business cycle, permanently eliminate recessions.

BLINDER: There was a view that developed in the 1960s and developed excessively, one must admit in retrospect, that we could steer the national economy pretty well, not perfectly, but pretty well. If you pick up Walter Heller's book that was written in the 1960s, Walter Heller was the head of the council of economic advisers for Kennedy. The amount of optimism exuded there is - seems almost laughable. This is a watch we're repairing.

DAVIDSON: One way the economy is not like a watch - to repair a watch you don't need politicians. Politicians took the Keynesian message that government spending can be good and they basically went nuts. They paid for the war on poverty and the Vietnam War. They sent a man to the moon, convinced that Keynes gave them a free pass for all this spending. For Keynesians, this is always a problem. Prescribing Keynesianism to some politicians is like prescribing crack to a coke addict. And in the 1970s, the patient hit rock bottom. We had high unemployment, and the Keynesian solution stopped working. We spent and spent, and unemployment only got worse. And we got inflation, something Keynesians had no answer for. After that, it was the Keynesians' turn to walk in the wilderness.

CHRIS EDWARDS: When I took macroeconomics in the 1980s and early 1990s, the textbooks explained the basic Keynesian system, but then spent a few chapters showing why the Keynesian system did not work.

DAVIDSON: This is economist Chris Edwards, with the avowedly anti-Keynesian Cato Institute. The think tank was founded in 1977, near Keynesianism's lowest point.

EDWARDS: I thought the debate was settled in the '80s and I thought we all agreed that Keynesianism doesn't work. But now with the new stimulus package before Congress, all these Keynesians have come out of the woodwork and I'm wondering where all the theorists are that oppose the Keynesian system.

DAVIDSON: Did you know there were Keynesians around?


EDWARDS: Sure. But I thought this sort of kindergarten Keynesianism, as I call it, the simple idea that the government could spend more money to grow the economy, I thought that really sort of simple Keynesian idea had died in the 1970s, but I was wrong.

DAVIDSON: Chris is part of a school of thought that replaced Keynesianism. That school says government spending causes more problems than it solves. To control an economy, these people think, the best way is to have the Fed, the Federal Reserve, control interest rates. And this view has held pretty much until exactly one month ago, December 16th, 2008 to be precise. That's the day the Fed tried to stabilized the economy by lowering interest rates all the way down to zero percent. They can't go lower. But the economy kept getting worst. Their main tool seemed to have stopped working. So economists and policy makers started looking around for some other way to fix things. They found that there's this one guy in particular who'd given a lot of thought to get out of a situation like this.


BLINDER: OK, so, here's the way Keynes would have done it. So you measure here output and then you have to have an estimate of what economist like to call potential GDP.

DAVIDSON: We're in Alan Blinder's office at Princeton which conveniently has a blackboard and he's up there applying Keynes' formula to figure out exactly what the Obama administration should spend to get us out of the mess we're in. It's actually pretty simple, you start with some estimates where the economy should be, where it actually is - you throw in something called the "Keynesian multiplier." Blinder does the math in about 14 seconds.

BLINDER: So, that would lead you to conclude that you needed about 650 billion as a stimulus. Voila!

DAVIDSON: Have you done this more rigorously for yourself?

BLINDER: I've not, but I hope they have.

DAVIDSON: Right now, a lot of economists are supporting the idea of a stimulus package. There are people you'd expect like Paul Krugman, a proud Keynesian at the New York Times and some surprises like President Ronald Reagan's chief economic adviser, Martin Feldstein.

BLUMBERG: But many of the economists say they just don't know. Financial catastrophes don't happen often enough to prove anything. In fact, as Alan Blinder will tell you, this is the problem with economics.

BLINDER: The biggest problem with learning things in economics is the inability to do controlled experiments. So we don't have, unlike what is the case in many but not all scientists - sciences, the definitive experiment, right? This experiment they did in the 1920s proved that Einstein was right about the perturbation of Mercury. They proved it. We can never do that in economics.

BLUMBERG: The best you can have is a really good theory.

BLINDER: The best you can have is a real good theory. It's not going to work perfectly all - in a textbook manner all the time.

DAVIDSON: The anti-Keynesians, they say this massive stimulus package is too risky an experiment on an unproven theory. It might not get us out of the recession. It might cause a vicious inflation, a bloated government, and we'll have a trillion more dollars in debt as a constraining burden on our kids and grand kids.

BLUMBERG: The Obama administration is betting this won't happen. They're trusting this theory. They're trusting Keynes. For This American Life, I'm Alex Blumberg.

DAVIDSON: And I'm Adam Davidson, NPR News.

NORRIS: There's more on Keynes and the stimulus on our Planet Money podcast and blog at npr.org/money.

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