The Keynesian shell game
By Scott Sumner
Ever since the spectacular implosion of Keynesian economics in 2013, I’ve seen increasingly desperate attempts to somehow salvage the model. In this post I’ll outline some of the arguments that I run across, and explain why they are misleading. I hope to leave you better prepared for future debates at the water cooler.
During the course of 2013, real GDP growth was almost twice as fast as during 2012, and nominal GDP growth also accelerated. Today some Keynesian like to minimize the austerity program of 2013, acting like nothing of importance happened. Let’s look at the record, starting with what Keynesians were saying in late 2012:
Responding to a letter by 80 CEOs published in the Wall Street Journal calling for budget cuts to reduce the deficit, 350 economists published a letter calling for job stimulus and growth instead.
That letter included this warning:
At the end of the year, we face a congressionally-created “fiscal cliff,” with automatic “sequestration” spending cuts everyone agrees should be stopped to prevent a double-dip recession.
Only about 6 weeks later Congress raised the payroll tax by 2 percentage points. Income taxes were raised at the same time. A few months later spending was slashed under the “sequester.” By April 2013, Keynesians like Mike Konczal and Paul Krugman were calling the austerity a “test” of the market monetarist proposition that fiscal austerity would be offset by monetary stimulus.
But the double-dip recession never happened; indeed growth sped up in 2013. I haven’t seen so many Keynesians get things wrong since that 1981 letter attacking Thatcher. So what could they possibly say in response? Here are things I often see in my comment section:
1. People claim that growth didn’t speed up in 2013, as compared to 2012. The trick here is that they use calendar year over calendar year growth rates, which means 2013 growth heavily reflects the very slow real GDP growth in the second half of 2012, before the austerity was imposed. Economists generally agree that when you have a shock that occurs at the beginning of a calendar year, you should look at growth over the course of the year (say Q4 to Q4), not the average GDP in 2013 compared with the average GDP in 2012. Using the correct method, RGDP growth accelerated substantially, from 1.60% in 2012 to 3.13% in 2013. That probably overstates things, but growth certainly didn’t slow.
3. The second trick is to downplay the amount of austerity. One trick is to use total government spending, including state and local spending, and then argue that austerity began earlier. But state and local spending is no more relevant to federal decisions over fiscal policy than is corporate investment. From the perspective of federal government policymakers, state and local spending and private investment are equally endogenous. Don’t be fooled by the term “G”, what matters is federal spending. State and local spending may or may not affect growth, but it’s not fiscal policy.
4. Another trick is to look at government output, ignoring taxes and transfers. This is often justified because the “G” in the GDP formula is output, not spending. Alternatively, some point to new Keynesian models featuring Ricardian equivalence to justify focusing on government output. But 99% of Keynesians don’t believe in Ricardian equivalence, and they constantly complain that benefit cuts and payroll tax increases will slow aggregate demand. So it’s a bit late in the day to suddenly argue that taxes and transfers don’t matter.
5. Pick up any textbook and they’ll tell you that Keynesian economics is about deficit spending. If you look at the official deficit figures you see an enormous drop in the deficit, from $1,087b in fiscal 2012 to only $680b in fiscal 2013. But it’s even worse for the Keynesians. Fiscal years run from October 1st to September 30th. But the 2013 austerity did not begin until the sharp tax increases of January 1st 2013, 3 months into the 2013 fiscal year. I tried to estimate the deficit for the calendar 2013 from this source, and came up with $1061b in 2012 and only $561b in 2013, an astounding drop of $500 billion in just one year. That’s austerity! Yes, the numbers that matter are the cyclically adjusted figures. But no one knows exactly where we are in the business cycle, and in any case the growth rate is not high enough relative to trend for the cyclically adjusted figures to be all that different from the unadjusted figures under any plausible corrections. There is no doubt that 2013 was a year of austerity (or at least dramatically less stimulus, if you are a conservative who cannot stomach calling $561b deficits “austerity.”)
Don’t be fooled by Keynesian excuses. They are the ones that warned about the effects of 2013 austerity. They are the ones who said it was a test of market monetarism. We should take them at their word.