Reynolds on Keynes, Minsky & Vulgar Keynesianism

[Greg Ransom <gregbransom@xxxxxxxx>]

"Vulgar Keynesianism visible" by Alan Reynolds

     Influential legislators are talking about tax policy as
if fixing an economic downturn was a simple matter of "putting money
into peoples´ pockets."
     Democratic leaders Tom Daschle and Dick Gephardt thus define
the issue entirely in terms of revenues lost as though it
makes no difference how the planned $100 billion "stimulus" for
fiscal 2001-2002 is allocated. Their preference is to keep
collecting excess taxes (the surplus) from taxpayers with higher
incomes in order to write so-called "rebate" checks to those
who contributed little or nothing to the surplus.
     After all, if prosperity were just a matter of putting money
into consumers´ pockets, what difference could it make if the
government takes the money from Smith and gives it to Jones? This
redefinition of taxpayer-financed gifts as "rebates" makes
no more sense than dropping money from helicopters, yet it is
being taken seriously by those who refuse to take economics
seriously. Critics call it Keynesian economics. But, as we will
see, that is an insult to John Maynard Keynes, the famed British
economist of the 1930s.
     In his 1945 classic, "The Open Society and Its Enemies,"
Karl Popper distinguished between "vulgar Marxism" and the
actual writings of Marx. In the same vein, printing "rebate"
checks to "put money in consumers´ pockets" is vulgar Keynesianism
the latest epidemic in the nation´s capital. Consider these examples:
     At a hearing of the House Ways and Means Committee, an economist
from the McCain-Republican camp testified that the
quickest way to stimulate the economy was to cut the lowest tax rate
first, since those with low incomes will spend it all rather
than waste it by saving. That was vulgar Keynesianism.
     Another economist wrote an op ed in a conservative newspaper
claiming lower interest rates from the Fed could not help
the economy because consumers already had too much debt. That focus
on consumers and credit was vulgar Keynesianism.
     Fed Chairman Alan Greenspan persuaded journalists to focus
on consumer confidence surveys that the Fed´s own research
shows have no predictive value at all. The implication that the
difference between prosperity and recession rests on consumer
sentiment was, of course, vulgar Keynesianism.
     Keynes advanced "an investment theory of business cycles,"
to borrow Hyman Minsky´s description not a consumption
theory. He would not have been surprised that the current slump
originated in collapsing business profits and investment, not
consumer frugality. Consumption grew at a 2.1 percent rate in
the second quarter of last year, when the entire economy grew
by 5.7 percent. But consumption has continued growing at a 2 percent
to 3 percent rate ever since. Investment, not
consumption, made economic growth go flat.
     Keynes taught that consumer spending depends on national
income not that income depends on consumer spending. He did
not believe recessions were caused by spontaneous waves consumer
frugality, nor that recessions could therefore be cured by
"putting money in consumers´ pockets." On the contrary, Keynes
understood that recessions are always caused by a collapse
of business investment. In his 1936 "General Theory," he wrote
that a decrease "in the rate of investment will have to carry with
it a decrease in the rate of consumption."And, Keynes added,
"Employment can only increase . . . with an increase in
investment."
     After Keynes, Milton Friedman and Franco Modigliani received
Nobel Prizes for demonstrating that consumption depends
on long-term income and wealth, not ephemeral windfalls from
rebates or a temporary cut in withholding. A one-time "rebate"
that is unrelated to productive activity cannot even be expected
to stimulate consumption, much less production. Since the
rebate has no effect on permanent income, it can have no significant
effect on consumption. Nobody buys a new house or car
because of a minuscule one-time windfall.
     Business investment has been in trouble because companies
have been reporting disappointing profits or losses. Over the
past year, profit margins were pinched by rising costs of energy,
labor, credit and taxes. As Keynes wrote in 1931, "There is no
possible means of curing unemployment except by restoring to
employers a proper margin of profit."
     What does the slump in profit margins and business investment
have to do with consumer spending? Not much. Many of the
world´s largest corporations mainly sell to other firms. When
consumers go shopping, they are unlikely to pick up something
from Cisco, Nortel, Oracle or Sun Microsystems.
     Keynesian vulgarization has fostered the foolish habit of
gauging the economic benefits of tax policy solely by the amount of
money the government loses. The one-year cost of rebates and
gimmicks has escalated from $60 billion to $100 billion, but
slashing the four highest tax rates to beween 25 percent and
33 percent immediately would cost only $45 billion. The more
costly rebate policy is the economic equivalent of tossing
taxpayers´ hard-earned money (the surplus) into a wishing well. But
using half of that money to begin a durable reduction of tax
rates would be extremely helpful.
     A permanent reduction in the higher marginal tax rates
would help the economy immediately by creating expectations that a
larger portion of future income will be available to repay debts
and rebuild saving, rather than to pay taxes. By contrast, doling
out little "rebate" checks that are totally unrelated to taxes
paid would be an expensive way to accomplish literally nothing.

Alan Reynolds is a senior fellow with the Cato Institute.


Washington Times May 25, 2001
http://www.washtimes.com/commentary/20010525-495416.htm


Greg Ransom
www.hayekcenter.org