Keynesian Economics has nothing to do with "Big Government"

7/24/2012 02:08:00 PM
Figure 1. Ohio legislators lobby Roosevelt in 1938 for $80 million for flood
control along the Ohio river. On the far right is Brent Spence.

Paul Krugman rails against the logical fallacy that opponents of counter-cyclical fiscal policy often (usually?) rely on to argue their case. As Krugman says now, five years into the financial crisis, you might have imagined that people would stop spouting this line: “You say government spending can create jobs — but then why isn’t Greece booming? Huh? Huh?”
This gets at a very important point. The implication of Keynesian (or New Keynesian, or Neoclassical synthesis or whatever--basically all of mainstream modern macroeconomics) is that government spending  should be countercyclical. What this means is that government spending should be highest when the economy is at its worse, and lowest when the economy is at best. This is devoid of any implications about the size of government--we can engage in countercyclical spending while keeping government small, or while keeping government big, it doesn't matter.

Think about it this way. During the recession, the economy fell to $1 trillion below its potential output level. The implication there is that we need the government to increase spending by roughly $1 trillion per year until the economy returns to normal. That $1 trillion spending increase called for by keynesian policy is temporary, not a permanent increase in the size of government. Now maybe there are some who argue that even a temporary increase in spending represents an increase in the size of government. But again, this is completely wrong, because we can always reduce spending in non-recession years by however much we want, so that the overall level of spending, including the temporary stimulus, is the same as what we would have wanted if there had been no recession. To summarize the keynesian position, what we should do during a recession is take spending projects that the government was planning to do in the future anyways, and instead start them during the recession.

The implication is that we can match any size of stimulus spending with any desired size of government. The idea is that all that road work you are finally starting to see around your hometown now that sales tax revenues are starting to recover should have been done when unemployment was still more than 10%. And all the new bridges that the government is planning to build at some future date--the replacement for the Brent Spence bridge in Cincinnati comes to mind--should be started now while unemployment is 8.2%, not in the future after everyone is able to get a job anyways.

All that Keynes really said is that it doesn't matter that governments don't have as much revenue during recessions--both the treasuries and the people will be better if the government does its spending in recessions when resources are idle than in expansions when resources are in high demand. Interest rates on government bonds will be low enough to make it worth their while.