Keynes Revisited

Richard Posner has written a good defense of Keynes’ theory of recessions. The critical idea, or so it seems to me, is this:

For when the demand for goods and services falls, as in the present downturn, the economic environment becomes unsettled and even the near future becomes unpredictable. This dampens businessmen’s animal spirits and causes consumers to hoard–and businessmen as well. For when the urge to action deserts them, they build up their cash balances, in lieu of active investment, in order to hedge against uncertainty. Owing to uncertainty, businessmen even in the best of times lack “strong roots of conviction” in their estimate of what the future holds, and so a sudden change in economic conditions can paralyze them. If so, a downward spiral will develop, as falling demand and falling investment reinforce each other, causing layoffs that reduce incomes and therefore consumption and production, and so induce more layoffs.

That’s easy to accept. The essence of Keynes’ remedy was for government to engage in massive spending in order to restore confidence by business owners. But I have to ask: why would business owners be more confident of the future when they can see that greater economic activity is occurring mostly at the whim of politicians? Wouldn’t this make the future less predictable and further reduce confidence?

The alternative view is that there are normal business cycles and that recessions occur as the result of too many bad investments. Government activity merely serves to amplify the business cycles, making the good times artificially good [see housing boom] and the bad times needlessly bad [see debt overhang].

But regardless of who is right, politicians seem naturally drawn to the Keynesian model since it allows them to “do something” and demonstrate their concern for their constituents, regardless of the real world impacts.

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