Obama chooses major stimulus.Keynes' approach

December 7, 2008

President elect Barack Obama has made it clear that he is more concerned about having a large enough stimulus package to be effective as opposed to worrying about the size of the deficit. Obama is showing great wisdom in his approach to the problem clearly understanding that the US is well positioned to finance a substantial stimulus. If it is well designed, pays attention to the high employment budget balance target and ensures that there is a stimulative primary deficit even if   the economy were at full employment so as to ensure that the deficit is positive and proactive and not just a passive deficit that results from the higher unemployment it will be effective. If the stimulus is large enough and effectively designed and implemented it will have a large multiplier secondary effect which will go some distance to reducing the rate of job loss and possibly even restore a significant number of jobs as the economy begins its path toward recovery.
The contrast between the intelligent, thoughtful forward looking approach of Obama and the stuck in the past fearful anti deficit hysteria of a number of Canadian federal politicians is telling. The United States needs a major stimulus package . It will get it. Canada needs one as well. Will we get it ?

The Keynes approach

There is a new 2008 edition out of British economist and former politician Michael Stewart's book Keynes and after.In it according to a reviewer on the Amazon site Stewart apparently argues that the essence of Keynes lies in his solution for promoting full employment namely budget deficits and appropriate fiscal policy. Interest rate policy and money drop by the wayside.

In fact, of course any careful reading of a larger chunk   of Keynes' work including the Treatise on Money, the articles, reviews and letters that led up to the General theory and the articles, reviews and letters that followed the GT's appearance leads us to a more complex understanding.( see the two volumes of the Treatise on Money published in 1930, volume 18 of Keynes Collected Works(CW) entitled Preparation and After, the final volume before the index of CW which contains previously lost manuscripts and correspondence found at Tilton in a wicker basket in   the   1970s and the General Theory.) Keynes believed in his earlier work right up until the General Theory that an appropriate monetary policy which kept interest rates low was an essential ingredient in any policy directed at low unemployment. he also believed in an active fiscal policy directed at demand stimulation through infrastructure spending and a social influence over the investment process. This was the explanation for his inclusion of his famous satirical advocacy of burying bank notes in bottles underground and selling certificates to have them dug up as a politically and free market acceptable method of stimulating effective demand since there was so much conservative opposition to the much better alternative of infrastructure investment in roads,public transport, housing and education . This was also why he supported Kahn's theory of the multiplier against the Treasury conservative view that government spending and investment would crowd out private investment.

In fact, Keynes believed it would crowd it in rather than out.

Keynes also believed in uncertainty and risk and the likelihood that the mob psychology of the stock markets as he described it in the Treatise and later in the General theory in his chapter on expectations would lead to an unstable investment climate and hence an undersupply of investment necessary to achieve full employment. So one needs both accomodating monetary policy, effective regulation of the stock markets and a major deficit financed program of infrastructure investment to provide the essential stimulus to lower unemployment and match savings and investment at a high rate of employment.

Finally Keynes always believed that once you had defeated deflation and were lowering unemployment prices would begin to rise well before the point of full employment was reached. But this natural rate of inflation was a desirable target to ensure   against stagnation and inadequate effective demand.One should never assume that once one passed this point that inflation might not be a problem to be dealt with but the source of the true inflation was to be found in bottlenecks, co-ordination and disproportionality mismatches between savings and investment decisions and wage and profit push. inflation was not contrary to Friedman purely a monetary phenomenon.