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I saw a Paul Krugman article from late last year posted in a forum recently.  In the article, Krugman argues why Keynes was right on government spending, and goes on to blame the problems in the US and the Eurozone trouble on a failure to abide by Keynesian policies.

Krugman:  Keynes Was Right

In actuality, Krugman exemplifies precisely why Keynes’ spending policies have never worked very well. It’s not that Keynes was wrong on the theory.  Recessions are often caused by monetary contraction and running government deficits creates more money supply, which can fix this issue in a blunt-force way (albeit, sometimes very inefficiently).  Oftentimes, these monetary contractions are even created by the government itself, as was the case during the Great Depression.

The real problem is that government policy makers and even many economists (such as Krugman) seem to believe that we are always in a “recession” and that deficit spending is the solution AT ALL TIMES!  Krugman thought more spending was the solution in 2001, and then in 2003, and then in 2005, and then in 2009, and now in 2012.  Krugman thought we needed more spending during the tech bubble, the housing bubble, and now in 2012, with increasing signs of stagflation. Under Krugman’s reasoning, we’ve needed a Keynesian stimulus for the entirety of the past century!

Politicians are no better than Krugman, either.  How many politicians were talking about “stimulating” the economy right in the midst of the housing bubble?  If you think we’re bad here in the US, check out China which has been on perma-stimulus status for over a decade.

This destroys the basic foundation underlying Keynesian spending theory.  The idea behind it is that the “animal spirits” of the market will create boom and bust cycles and that the more level-headed government officials can step in and help soften these cycles.  In reality, there’s no reason that government officials are any less motivated by these “animal spirits” than the individuals in the private sector, and the normal result is that the government exacerbates the boom and bust cycles with dim-witted policies.

Keynes was right on a strictly theoretical level.  The Great Depression was caused by artificial contraction of the money supply and running budget deficits was the best way to offset this contraction and normalize money supply growth (which could then help normalize the economy).  But the problem is that Keynes examined the irrationality of private sector actors, but believed that government officials were bound by some completely different set of behavioral norms.  In reality, government officials are often even more egregious than the private sector.

Moreover, government officials can often be so completely wasteful in spending policies, that they still manage to create virtually zero economic growth, while increasing the money supply.  The 2009 stimulus act here in the US under President Obama is a great example of this.  The bill was loaded down with pork-barrel spending, much of which provided very few real benefits to the economy.  While it might have helped offset the monetary contraction of the time, it was (a) too late to matter as the contraction had already been stopped by the time the spending went into affect, and (b) was so extremely wasteful in its spending that it likely created very few jobs, while creating significantly more inflation.

I still think Keynes was one of the best economists of the 20th Century and people focus too much on his spending philosophy, and ignore the work he did on trade.  But it’s increasingly clear to me, at least, that Keynes’ spending philosophy is one of those things that works well in theory with rational and completely unself-interested government officials.  It does not work in reality because government officials are no more wise, benevolent, or enlightened than the rest of us.   Keynesian spending policies look more and more flawed through the lens of history.

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