The Keynesian Dead End: Spending our way to prosperity is going out of style

Today’s G-20 meeting has been advertised as a showdown between the U.S. and Europe over more spending “stimulus,” and so it is. But the larger story is the end of the neo-Keynesian economic moment, and perhaps the start of a healthier policy turn.

For going on three years, the developed world’s economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity. It hasn’t turned out that way.

Now the political and fiscal bills are coming due even as the U.S. and European economies are merely muddling along. The Europeans have had enough and want to swear off the sauce, while the Obama Administration wants to keep running a bar tab. So this would seem to be a good time to examine recent policy history and assess the results.

In other words, Keynesianism worked in the 1980’s but it is not working today. What is the difference that makes Keynesianism less effective?

As the article says:

“Like many bad ideas, the current Keynesian revival began under George W. Bush. Larry Summers, then a private economist, told Congress that a “timely, targeted and temporary” spending program of $150 billion was urgently needed to boost consumer “demand.” Democrats who had retaken Congress adopted the idea—they love an excuse to spend—and the politically tapped-out Mr. Bush went along with $168 billion in spending and one-time tax rebates.”


“The larger lesson here is about policy. The original sin—and it was nearly global—was to revive the Keynesian economic model that had last cracked up in the 1970s, while forgetting the lessons of the long prosperity from 1982 through 2007.”

The point is that the '80’s didn’t rely on Keynesian economics.

Which of course is pure nonsense. The 1980’s was pure keynesianism. First of all, government spending went up, which certainly is a keynesian policy. Second, taxes were cut which is another keynesian policy.

Suudy, thanks for posting this. Good topic.

The Keynesian philosophy has been in effect since the Federal Reserve System came into being in 1914. (Some argue it had in effect even before then, since other countries had central banks.) It has been refined several times, most notably during the Depression and after the complete removal of the gold standard in 1971 by Nixon. Interestingly enough, JFK tried to revive the silver certificates but he was killed shortly thereafter.

PS. There was a mild exception in the recession of 1921 when both the Fed and the US govt failed to enact what we consider any stimulus and the economy recovered.

Actually, if you look at the historical data, you find that our least Keynesian president was Bill Clinton. He manage to accomplish two things that Reagan never could. First of all, Clinton was much better at controlling government spending. Adjusted for inflation government spending grew less under Clinton than under Reagan. The second thing that Clinton managed to accomplish was a balanced budget.

Greenspan kept the rates high (7% or so) to discourage any government spending during the Clinton years. Also provided ample interest income to encourage private spending and investing into high-techs and generate growth and tax revenues. A high interest rate climate provides a couple of benefits; keeps asset prices low and encourages refinancing as interest rates are lowered and capital gains are realized. This was also evident during the mid Reagan years. At the current 0%, Bernanke can do very little; he really boxed himself into a corner. No one wants to buy into a sinking market no matter what the rates are.

Keynesian economics are solid- however, Keynes only recommended deficit spending to pull out of a recession. Most western governments however, take that as license to run a permanent deficit- which is NOT consistent with Keynes’s ideas.

As we all know, spending originates in the House. Clinton was fortunate enough to have a Republican House during the last years of his presidency.

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