Keynes Gone Wild

Among the most important news items of the day is a Bloomberg.com writeup of the "New Keynesian" who now appears to have replaced Milton Friedman as the go-to guy for Administration economists. "Yale’s Tobin Guides Obama From Grave as Friedman Is Eclipsed" describes the statist approach to government economic policy of Dr. Tobin. Here's an excerpt:

Like Keynes, Tobin was an advocate for the role of government in maintaining full employment, said James Galbraith, an economist at the University of Texas in Austin. The current economic and financial crisis has validated that philosophy, said Galbraith, a former Tobin student and the son of the late John Kenneth Galbraith, who was a friend of Tobin.

“It’s clear that the position that the federal government has a responsibility for the level of employment, for the economy, has prevailed,” Galbraith said. “The position that the Fed can walk away from the level of employment has completely collapsed. That was the absolutely dominant position coming out of the University of Chicago.”

In contrast to the Friedman-influenced proponents of tax cuts, deregulation and tight control of the money supply, followers of Tobin are more receptive to government intervention in the economy, including stimulus spending.

“I do not believe that over the next two years, we can make major deficit reduction or balancing the budget a goal,” Goolsbee, nominated by Obama to the Council of Economic Advisers, said at a Senate hearing on Jan. 15. “I think that would run the risk of repeating one of the mistakes of Herbert Hoover that led us into Depression.”

The Galbraith and Goolsbee arguments are against straw men. Re Galbraith, the Fed is by law mandated to work toward full employment as one of its two main policy goals, the other being low inflation. What Dr. Galbraith should have said is that the Federal Government (which was always distinct from the Federal Reserve Board before Dr. Bernanke joined forces with Treasury) has under all presidents since FDR adjusted fiscal policy to keep the economy humming. The Fed is supposed to limit itself to the critical task of backstopping the banking system, but was never ever charged with determining overall policy, which has to belong to elected officials who are accountable to the public via elections.

Re Goolsbee, no one has proposed immediately balancing the budget or even making a major deficit reduction effort. But I for one will argue against increasingly massive budget deficits at a time when bond traders are, unbelievably, now pricing in a 5% chance that the U.S. Government will default at some point on 5-year Treasury debt.

Unfortunately for Dr. Galbraith and Goolsbee, they can point to no precedent in any country where massive deficit spending has provided any intermediate- or long-term benefits to the economy.

The Obama budget proposal, which may be over-optimistic on revenues, is for a $2 Trillion cash deficit assuming the $750 Billion "placeholder" giveaway to banksters occurs. This is basically proposing to spend $2 for every $1 in revenues.

This is why markets are acting oddly. At a time of negative inflation, the ultimate inflation hedge of gold has risen in price and the ultimate deflation hedge of Treasuries has been falling in price.

It is long past time to invoke Herbert Hoover. You may as well invoke Nero and boast that your Administration doesn't even own a fiddle. Not being Nero, Hitler or Hoover doesn't mean that your policies are optimal.

Forget "Girls Gone Wild". This is Keynesianism gone wilder.

Copyright (C) Long Lake LLC 2009