Fiscal Stimulus Debate: Oops, We’re Using The Wrong Keynes!

Given today’s worsening financial and economic crisis, the debate on the viability of the fiscal stimulus (government spending) patterned after John Maynard Keynes theories continues to rage.

courtesy of American.com

But, unfortunately, both proponents (including uber-Keynesians) and detractors have been citing the "wrong" theories of “rock star” economist JM Keynes. That’s according to Professor Rizzo who wrote, ``we should pay attention to his mature ideas rather than to the textbook versions of what he said, some of which reflect Keynes’s earlier thinking.”

So what were the thoughts of the “matured” Keynes?

Again Professor Rizzo (all bold highlights mine), ``Keynes did not think that public works expenditure was very effective in countering existing or impending recessions. He believed that it was difficult to get the timing right.

``In the first place, he preferred that such investments be made without deficits. But if they were to be made as “loan expenditure”—that is, through a deficit in the portion of the government’s budget allocated to long-term expenditures like infrastructure—the expenditure should be covered by a surplus in the portion of the budget allocated to ordinary expenses like transfer payments, or through a special fund accumulated in prosperous times for just such purposes. If a deficit were incurred, the investments should be “self-liquidating,” that is they should repay their costs over the long run. Thus his strong, but not rigid, preference was against deficit-financed public works.

``The more fundamental reasons for his preference against deficit-financed public works, however, emerge from the theoretical framework he built in his masterwork General Theory of Employment, Interest and Money (1936). As economists Bradley Bateman and Allan Meltzer stress, Keynes was convinced that avoiding depressions required the maintenance of a high level of investor confidence. He believed that (in general and not just during slumps) confidence tended to be too low. This low confidence was due to radical uncertainty generated by speculation inherent in financial markets, especially the stock exchange. This speculation could give rise to unsustainable asset bubbles. The ever-present threat of such speculative activity creates instability in the expectation of investment returns. As a result, investment spending will fluctuate unpredictably. This in turn creates further instability of investor expectations.

``In Keynes’s view, the financial uncertainty generated by such speculation was an unnecessary social burden. It tended to keep long-term interest rates above where they would lead to full employment. The task of good economic management is to reduce this uncertainty burden and lower long-term interest rates through a kind of “socialization of investment.” The state in one way or another (Keynes is not entirely clear on this) should undertake large investments with no thought of speculative gains or advantage. The long-term social return on capital should be its only guide. And it should do this reliably, as part of a well thought-out plan, and on a permanent basis. Stabilization is to be achieved not by temporary and discretionary policies, but by permanent changes. Stimulus follows stability, not vice versa.

Read the rest here

Some observations:

The matured Keynes admits he does not “think that public works expenditure was very effective in countering existing or impending recessions”

Goes to show how interventionists have been using Keynes inappropriately for intellectual cover.

Finally, don’t be slaves of defunct immature economist!

(Hat Tip: Café Hayek)