Tyler Cowan's Keynes Versus the One We All Know and Love

Sunday, 03 February 2013 08:42

Tyler Cowan argues in his column today that we should let the sequester cuts go into effect but his argument is a bit hard to follow. He tells readers:

"One common argument against letting this process run its course is a Keynesian claim — namely, that cuts or slowdowns in government spending can throw an economy into recession by lowering total demand for goods and services. Nonetheless, spending cuts of the right kind can help an economy."

He then goes on to point out that we can have cuts in military spending, farm subsidies and other areas that could benefit the economy.

This is where the story gets confusing. If we are looking to Keynes then the argument is straightforward, if we make cuts to the budget in a period of high unemployment like the present, then we are throwing more people out of work. These people will not be re-employed elsewhere, or if they are, they will be displacing other workers. (Btw, it's not clear why the word "recession" appears in the paragraph. The point is simply that we would have slower growth and fewer jobs, there is no magic recession threshold in any Keynesian text I have seen.)

This Keynesian argument that cuts leads to unemployment in a depressed economy applies regardless of whether the spending is for good or bad purposes. In other words, even if we cut $100 billion from the government Department of Waste, Fraud, and Abuse, which does nothing but write reports and throw them in the garbage, it would still slow growth and raise unemployment. The problem facing the economy right now is demand, demand, and demand. If you reduce demand, you hurt the economy.

In the longer term, when the economy does get back to something resembling full employment, it will be helpful if we can eliminate wasteful areas of government spending. Of course it would also help the economy if we can expand useful areas of government spending. But that is not particularly a Keynesian story. I assume that almost anyone would agree with these propositions even if they might draw the lines differently between wasteful and useful.

Anyhow, the reference to Keynes is a bit peculiar here. If Cowan thinks he has argued for cuts that are consistent with the Keynesian view, he is mistaken. The idea that cuts in areas of relatively strong demand like health care will have less effect on employment is at best true in only a trivial sense. Wages are not rising especially rapidly in this sector, it is not as though we have any reason to believe that there would be large numbers of additional hires to replace workers who lose their jobs due to government cutbacks, even if the impact might be marginally less than cutbacks in other sectors.

Of course Cowan also brings in the reference to investor sentiment and refers to the bond-rating agencies. This is a strange argument for a strong believer in markets. The markets are yelling at us as loudly as they can that they have no fears about the health of the U.S. government and its ability to pay its debts, hence the 2.0 percent nominal interest rates on 10-year Treasury bonds. Why would Cowan take the word of bond-rating agencies who thought subpime mortgage backed securities were Aaa over the view of financial markets?

Anyhow, it is hard to know from this column whether Cowan thinks his preferred list of cuts won't slow growth and add to unemployment or whether the additional unemployment is a price worth paying to make the bond-rating agencies happy.