Keynes, Keynesians, the Long Run, and Fiscal Policy
One dead giveaway that someone pretending to be an authority on economics is in fact faking it is misuse of the famous Keynes line about the long run. Here’s the actual quote:
But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.
As I’ve written before, Keynes’s point here is that economic models are incomplete, suspect, and not much use if they can’t explain what happens year to year, but can only tell you where things will supposedly end up after a lot of time has passed. It’s an appeal for better analysis, not for ignoring the future; and anyone who tries to make it into some kind of moral indictment of Keynesian thought has forfeited any right to be taken seriously.
And there’s an important corollary: how you should go about getting to some desired long-run outcome may depend a lot on how you think the economy works in the short run.
I don’t like the framing of this Blanchard-Leigh piece , which simply takes it as a given that we should be engaged in fiscal consolidation even in the short run, and the only question is how much. The truth is that the economics suggests strongly that we should be engaged in fiscal expansion right now. Still, framing aside, Blanchard and Leigh do get at the right issue: because the short-run effects of fiscal policy may differ greatly depending on the state of the economy, appropriate policy depends hugely on where we are right now.
And look, this isn’t hard. The overwhelming fact about our current situation is that conventional monetary policy is played out, with short-run interest rates at zero. This means that there is no easy way to offset the contractionary effects of fiscal austerity (maybe there are exotic ways to do something, but they’re tricky and unproved). And this in turn means that austerity right now is a terrible idea: any fiscal savings come at the expense of reduced output and higher unemployment. Indeed, even the fiscal savings are likely to be small and maybe even nonexistent: lower output and employment reduces revenues, and may inflict long-run economic damage that actually worsens the long-run fiscal position.
The other things B-L mention,like credit constraints, just reinforce this basic point. (By the way: Gillian Tett notes today that consumer spending is now fluctuating dramatically with the timing of paychecks, suggesting a lot of people living hand to mouth. What she doesn’t point out is that this is a world in which Ricardian equivalence, in which expectations of future taxes drive current spending, is even wronger than usual — and fiscal multipliers will be large).
The point, then, is not to ignore the long run; it is to recognize that the boom, not the slump, is the time for austerity, and spending cuts right now are disastrous policy. In the long run we are all dead; the point is to avoid killing our economy before its time.
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