Beyond the 1937-like craze in Congress today over cutting the budget deficit, there is a more serious debate going on in the US over how to stimulate aggregate economic demand in order to spur more rapid job growth. In this debate, there are competing views over whether to raise spending or cut taxes – sometimes referred to as left Keynesians and right Keynesians. Macroeconomists have mainly favored the spending route because the historical evidence is that spending gives more bang for the deficit buck since the initial impact brings a one-for-one boost to demand, while a tax cut initially loses some bang because tax cut recipients initially save a part of their higher disposable income. But there is agreement among those who engage in this debate that tax cuts too will stimulate demand and job growth, especially when they are aimed at lower income Americans who spend more of their disposable income on the margin than do the rich.
In fact, the greatest moment of success of Keynesian policy in the history of the United States is not the New Deal, as is often claimed by proponents of greater deficit spending in the current crisis. The height of the influence and success of Keynesian policy advisers was the Kennedy administration’s income tax cut of $13.5 billion over three years. The policy was strongly urged by President Kennedy’s Council of Economic Advisers, led by the great American Keynesian economists James Tobin, Walter Heller and Arthur Okun. Facing unemployment rates around 7 percent, the economists sought to bring it down to 4 percent. By early 1964 (after Kennedy’s death), the proposal was passed into law. The tax cut is attributed with moving the economy to 4 percent unemployment and a very high rate of capacity utilization. In his history of that era, Michael Bernstein (A Perilous Progress) writes that “by the fall of 1964 the success of the tax cut was so apparent that, in the words of Arthur Okun, ‘economists were riding about as high a crest of esteem and respect …as had ever been achieved.’ ” It was the bold advice of Democrats Heller, Tobin and Okun that initially established the Council of Economic Advisers as an important political institution.
Kennedy had the luxury of a Congress controlled by the Democrats. Today, President Obama does not have this luxury. Thus, a leader who understands the desperate need for stimulating demand also faces a Congress that will not move an inch in the direction of left Keynesianism. Obama’s jobs proposal recognizes the essential need for demand stimulus, that fallacy of the right-wing argument that a higher deficit in the short-run creates damaging psychological uncertainty, and the political reality that right Keynesianism may be the only route to demand stimulus. While the proposal of $447 billion in deficit stimulus, $253 billion of which takes the form of tax cuts, is too small and comes disappointingly late in the business cycle, it nonetheless represents a very positive step in the current landscape of economic policy. In two senses, then, President Obama has done the right thing.
I’m wondering if compromise in terms of the size of the stimulus is working against Obama. Compromise may be necessary but there must be a certain threshold in terms of the stimulus’s efficacy. If the government spends $500 billion to stimulate the economy, but $1 trillion is what is really necessary to really get the economy going, then what you have is a short term gain, but, perhaps, a long term loss as conditions revert back to what they were. In essense then by limiting the size of the stimulus, the Republican claim that government spending doesn’t work may turn out to be a self-fulfilling prophecy.
Do you think that the same Keynesian theoretical principles and algorithms work in an economy which has structurally changed from the mid 20th Century? Much of what is spent today may be for goods and services provided by companies located in other countries.