Was Keynes Right?

Mr. Cool, otherwise known as our president, doesn't betray his emotions easily. But on Friday, as he introduced Paul Volcker and his new economic advisory board, Barack Obama let slip a little of his frustration over the prolonged battle over the economic stimulus bill. Describing the variety of appointees to his board, Obama said: "You've got some who are economists. And some folks who think they're economists." That provoked a laugh from the crowd in the East Room, which seemed to encourage the president to take the joke a step further. "These days," Obama said, "everybody thinks they're an economist."

That's about right. After two weeks of debate in Washington over the stimulus, we now know we have 100 economists in the Senate and 435 in the House. Not to mention the great economic minds that, all of a sudden, it seems, constitute most of the punditocracy and the blogosphere. Some of these people—most, I would say—are pretty certain some sort of stimulus is necessary. Others are convinced that a "Keynesian" approach to government intervention is just the latest version of voodoo economics. Some actually believe it will lead to a catastrophe worse than the one we're in. The question is, what is the truth? Is there, in fact, a truth about this debate?

You wouldn't necessarily know it from the discussion we've heard—even among real economists, who are not always the most gracious of discussants. Take the argument made in the Financial Times on Friday by Benn Steil, the director of international economics at the Council on Foreign Relations. Calling the stimulus debate a "triumph of hope over economics," Steil quoted French economist Jacques Rueff, who he said "demolished" in a 1947 paper the "Keynesian foundations" on which the stimulus is based. Steil wrote it's silly to think that money is now sitting "idle," requiring a stimulus. That aroused the ire of Brad DeLong, a Keynesian at Berkeley who writes the popular blog Grasping Reality With Both Hands. DeLong wrote that people should look at the data on the "velocity" of money circulation, which is way down. "That's what recessions are: times when money that in normal times greases the circular flow of economic activity instead sits idle." Steil, DeLong continued, must be "the only living man who thinks that French crank Jacques Rueff—who blamed the Great Depression on a sudden strengthening of labor union power at the start of the 1930s—'demolished' the 'foundations' of Keynesian economics." To be sure he was making himself clear, DeLong then called for Steil to be fired.

Oh, boy. Not much help there for us non-economists. The truth about Keynes, as best as I can ascertain it by canvassing prominent economists, is that DeLong is a lot more right than Steil. It's undeniable that the "foundations" of Keynesianism are still very much with us. They remain, in fact, the key conceptual framework through which we understand the economy, despite many dents from various Nobel-winning critics over the years. But it's also true that there's pretty thin evidence that a Keynesian stimulus of this size and this speed will work. Assuming the stimulus bill is passed in the coming hours, we are about to engage in a giant historical experiment. And we are the guinea pigs.

For a view from the reasonable center, I went to Harvard's Kenneth Rogoff, the former chief economist for the International Monetary Fund and an erstwhile adviser to John McCain who has a reputation for intellectual evenhandedness—and who was prescient about the current financial crisis. "There is tremendous skepticism, both based on theory and empirical evidence, about how much good all this is going to do," said Rogoff. "But there's also a recognition that the situation is so dangerous it has to be tried." Rogoff recalled going to a meeting of the American Economic Association two weeks ago. "You would find a number of people who were sure that tax cuts were the best way to have fiscal stimulus. Others say government spending. And a large number of us were not absolutely sure. There just isn't consensus about this."

Some economists, like Allan Meltzer of Carnegie Mellon, are absolutely sure of the opposite: "I think this is the introduction to a disaster," Meltzer says. "We're going to face a big inflation. Everybody talks about how much we need to do now. But no one talks about how we're going to unwind what we're doing now." Meltzer has been warning for months that the dramatic slashing of interest rates and surge of government spending—increased now by the nearly $1 trillion the stimulus will cost—is going to take the country back to 1970s-style "stagflation." "Keynesian theory is wrong," Meltzer said. "It doesn't work. I was honorary adviser to the Bank of Japan for 16 years. They put in bullet trains to every town and village in Japan. They paved over every piece of unpaved land. But it was only when they got around to easing their monetary policy that things started to improve."

Actually that didn't work too well either for the Japanese, who are still dragging. The fact is that there doesn't seem to be another situation that compares very well in scope to the one now being contemplated. Many economists point to the way the start of World War II finally pulled the United States out of the lingering Depression; the government's investment in war was like a giant fiscal (and monetary) stimulus. But going to war isn't exactly what we're doing now, thankfully: Many of the "jobs" created then were rather dangerous. "There was a conscription element to employment" that was very significant to the WWII "recovery," Rogoff points out.

What's no longer in dispute is that the economic crisis is the most serious many of us have seen in our lifetimes. Among the dire data points revealed this week: the country has now lost the most jobs in one month since 1974, has suffered the largest one-month drop in factory jobs since 1982 and the most jobs lost in 12 months since records were first kept in 1939 (of course the population was smaller back then too). So we'll need to try something. This isn't some "abstract debate," Obama noted Friday. Introducing Volcker's Economic Recovery Advisory Board, the president also said he wanted to avoid "group think." He won't have to worry about that. We'll be arguing about this stimulus for a long time to come.