Washington D.C., May 25th, 2012 – Not every college professor is a Keynesian, but there’s a good chance that yours is, or at least subscribes to part of the Keynesian mindset. If so, here are some fun facts you can bring up that desecrate the Keynesian worldview.
1.) The Not-So-Great Depression of 1920-21
The Great Depression (1929-1940+) was a horrible era, and it takes center stage in a lot of the current debate on economic policy. But few people mention the Depression of 1920-21. Unlike the Great Depression, which lasted one-and-a-half decades, the Depression of 1920 only lasted a year or so. During the Great Depression, massive government stimulus was used. Everyone knows that FDR was a big supporter of stimulus i.e. increasing the debt, spending money, and lowering interest rates, but it has been left out of the popular dialogue that Herbert Hoover also engaged in massive amounts of stimulus.(1) Now contrast that with the Depression of 1920, which was dealt with, as Jim Grant put it in the Washington Post:
By raising interest rates, reducing the public debt and balancing the federal budget. Eighteen months after the depression started, it ended.(2)
The Keynesian prescription of lowering interest rates and increasing government spending was not only ignored, but the exact opposite was done. Let 21st-century economists rub their eyes in disbelief.
2.) The Nonexistent Depression of 1946
Millions of Americans were employed in the armed services in 1945, and according to Keynesian logic, if they were all laid off at once and government spending was drastically cut, an enormous depression would result.
Prominent Keynesian Paul Samuelson said:
When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market…were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.
And indeed, the troops were all laid off, price controls ended, and federal government spending was cut by an incredible 61%. Did the worst economic catastrophe in history occur? No, the economy entered the enormous prosperity of the late 1940s and 1950s once resources were taken from the nonproductive state sector and given to the productive private sector.(3)
3.) The Harvard Business School Study that Shows Government Stimulus Hurts the Economy
The Keynesian theory doesn’t differentiate between good spending and bad spending: All spending in a recession/depression is good for the economy. In fact, Keynes notoriously claimed that,
If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez faireto dig the notes up again…there need be no more unemployment.(4)
So any study the shows government spending harms the economy deals a death blow to the Keynesian theory, but this is precisely what a Harvard Business School study found:
Recent research at Harvard Business School began with the premise that as a state’s congressional delegation grew in stature and power in Washington, D.C., local businesses would benefit from the increased federal spending sure to come their way. It turned out quite the opposite. In fact, professors Lauren Cohen, Joshua Coval, and Christopher Malloy discovered to their surprise that companies experienced lower sales and retrenched by cutting payroll, R&D, and other expenses…’ The average state experiences a 40 to 50 percent increase in earmark spending if its senator becomes chair of one of the top-three committees.’(5)
As the government spends more, it occupies a larger share of the economy: The government snatches resources up and crowds out private, productive investment.
4.) The 1870s
During the 1870s, pricesin America were falling. The Keynesian theory says that wages are “sticky downwards.” This means that, if prices as a whole are falling, there will be high unemployment. But this simply was not the case in the 1870s:
Historians long attributed the turmoil to a ‘great depression of the 1870′s.’ But recent detailed reconstructions of 19th-century data by economic historians show that there was no 1870′s depression: aside from a short recession in 1873, in fact, the decade saw possibly the fastest sustained growth in American history. Employment grew strongly, faster than the rate of immigration; consumption of food and other goods rose across the board. On a per capita basis, almost all output measures were up spectacularly. By the end of the decade, people were better housed, better clothed and lived on bigger farms.(6)
The economy increased production faster than the amount of dollars grew. Today, in a few very fast growing industries like cell phones and laptops, prices fall, but almost every other industry grows at a slower pace than the money supply, and this means prices rise. But this doesn’t have to be the case.
According to the Keynesian theory, either prices are rising and unemployment is falling, or prices are falling and unemployment is rising: A situation where prices are rising and unemployment is also rising is impossible. But this is untrue because,
In the 1970s, however, many Western countries experienced ‘stagflation,’ or simultaneous high unemployment and inflation, a phenomenon that contradicted Keynes’s view.(7)
To this day, macroeconomics students are taught that there is a direct trade-off between inflation and unemployment. But the 1970s show this is clearly false.
So, What’s Going On Here?
Despite the enormous failings of the Keynesian theory, how is it that this theory has remained the most-taught theory in the economics profession? It’s a question that’s up for debate, but I will point out this fact: The Federal Reserve is an institution that is explicitly Keynesian in its policies. The Fed lowers rates during recessions with the intent of stimulating the economy. This is also known as printing money. And what are some of the things it does with this money?
The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession.(8)
Now, I wouldn’t confront your professor and accuse him of corruption, he is the one grading you at the end of the day, but the Fed’s involvement in academia is an interesting fact to note.