How Would Keynes Save Our Economy?

Could economic ideas from a century ago help us now? You be the judge.

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In 2008 and 2009, we suffered the worst recession since the Great Depression. And now we're experiencing the weakest recovery in modern history. Here we are in the third year of an economic expansion, and we're barely back where we started. And by some measures, most importantly unemployment, we have failed to get back where we started.

To make matters worse, with the crisis in Europe and a slowdown in China, some people worry that another recession might be looming for next year, especially if we fall off the proverbial fiscal cliff of increased taxes and an end to government economic stimulus.

So let's go back to basics. What would Keyes do?

John Maynard Keynes (1883–1946) was the most influential economist of the 20th century. His ideas were adopted by Franklin D. Roosevelt to battle the Depression. Most economists, even many Republicans, credit Roosevelt and Keynesian economics with putting Americans back to work in the 1930s, helping the U.S. climb out of economic disaster, and setting the stage for the post-war economic boom. By 1971, President Richard Nixon admitted, “We’re all Keynesians now.”

Keynes theorized that during recessions, the public gets frightened and holds back on spending, resulting in more layoffs, which in turn produces less spending in a vicious circle of economic decline. The way to break the cycle, said Keynes, is to pump government spending into the economy by building roads and bridges and other public works. FDR even hired unemployed writers for a Federal Writers’ Project, traveling the country to produce guidebooks on states and cities.

Keynes overturned classical economic theory which said that free markets produce full employment. Keynes argued that aggregate demand determines the level of economic activity. If demand falls short, it leads to recession and high unemployment. Keynesian economics fell out of favor under President Reagan, but George Bush brought back Keynes in the 2000s, ramping up spending in order to pump up aggregate demand, and President Obama has tried to follow suit, with limited success.

So what would Keynes do in 2012? Let’s speculate:

1. Clearly, he would advise the federal government to invest in infrastructure, building roads and bridges, improving the electric grid, reinvigorating the space program, and developing alternative energy. Remember, it was FDR who built the alternative energy infrastructure of his day, from the Grand Coulee Dam to the Tennessee Valley Authority.

2. Keynes introduced the concept of price stickiness, which means that workers resist lowering their wages in the face of falling demand for labor. Keynes was undeniably liberal, yet he would certainly comprehend the current fiscal problems of cities and states, burdened with past promises of unaffordable pay packages for their workers. He would probably not support the draconian measures of officials like Wisconsin Governor Scott Walker to take away worker rights. But he probably would support less drastic cutbacks taking place in states like New York and California, where politicians are pushing to balance budgets in the face of lower economic conditions.

3. Keynes said if money saved exceeds the amount being invested, then unemployment will rise. Think of all the money hoarded on corporate balance sheets. Google alone is sitting on almost $50 billion in cash. Microsoft has almost $60 billion. He might well be in favor of lowering taxes on funds that American businesses hold overseas so they would bring the money home. And he would certainly support tax breaks and other incentives for corporations to build new factories and ramp up research and development.

4. Keynes felt that countries should not run large trade surpluses or deficits. He would likely be in favor of lowering the value of the dollar to boost American exports, give our multinational corporations a competitive edge, and reduce the U.S. trade deficit.

5. Finally, Keynes argued that World War II should be paid for with higher taxation. To the extent that higher taxation would not reduce demand—and there’s little evidence that modestly higher taxes on incomes above $250,000 would reduce aggregate demand, because these are the people who are hoarding "too much" cash—he would be in favor of increasing taxes on super-rich, and maybe even the near-rich, to help pay for our military ventures, finance infrastructure investment, and narrow the budget deficit.

Tom Sightings is a former publishing executive who was eased into early retirement in his mid-50s. He lives in the New York area and blogs at Sightings at 60, where he covers health, finance, retirement, and other concerns of baby boomers who realize that somehow they have grown up.