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31 January 2009

More Perspective on Keynesianism's Failures

Ike Brannon, a former Senior Advisor of the U.S. Treasury and Chris Edwards of the Cato Institute wrote a short article in the Cato Institute Tax & Budget Bulletin entitled The Troubling Return of Keynesianism. You can subscribe to the Tax & Budget Bulletin here.

They point out that simplistic Keynesianism ended with its clearly failed policies of the 1970s when inflation took off and government efforts to create jobs clearly failed. History showed that stimulus actions were always too ill-timed or too ill-suited to have actually helped the economy. Politicians were also commonly driven by political motives which were not in the public interest. The failure of Keynesianism was demonstrated by the Nobel-prize winner Milton Friedman. Others replaced Keynesianism with "rational expectations" theory, which held that people make reasoned economic decisions based on their expectations of the future. Government cannot systematically fool them into taking actions which make them worse off.

John Cochrane of the University of Chicago noted that the idea of fiscal stimulus is "taught only for its fallacies" in university courses these days. Thomas Sargent of New York University says "the calculations that I have seen supporting the stimulus package are back-of-the-envelope ones that ignore what we have learned in the last 60 years of macroeconomic research." Robert Barro of Harvard University says the stimulus plan does not make sense. Just because the economy is in crisis, it does "not invalidate everything we have learned about macroeconomics since 1936." Other top macroeconomists such as John Taylor of Stanford University and Greg Mankiw of Harvard are also critical of the idea that the Obama stimulus plan will help the economy.

So, what have macroeconomists learned that can be helpful to the economy? Stop trying to cope with the business cycle with its short term time horizon and deal with long-term economic growth. They have learned to concentrate their efforts on tax reform, regulation, and trade issues.

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