OPINION

The best stimulus is no stimulus at all

Keynesian economics turned government profligacy from a vice into a virtue

ANDREW COYNE February 18 2008
OPINION

The best stimulus is no stimulus at all

Keynesian economics turned government profligacy from a vice into a virtue

ANDREW COYNE February 18 2008

The best stimulus is no stimulus at all

OPINION

Keynesian economics turned government profligacy from a vice into a virtue

ANDREW COYNE

One consequence of any long period of prosperity, such as we have enjoyed since 1991, is a certain incaution. It has been almost a generation since the last recession—just two negative quarters in the last 66—so it is perhaps not surprising that some investors should have imagined the good times would never end, and taken on more risk than might have been prudent. The carnage on the markets of recent weeks is a necessary corrective to these excesses.

The other consequence of prosperity is what might be called policy nostalgia. As memories of the last recession fade, the fierce debates of previous decades over what government can or ought to do to “stimulate” the economy are forgotten also. Policies one had thought were discredited long ago are remembered in a hazy afterglow, as if the prosperity we have since enjoyed were somehow their effect, and not their disproof. Or as the Wall Street Journal headlined a recent editorial, in ironic echo of Richard Nixon, “We’re all Keynesians now.”

It was Keynes who famously said that “in the long run we are all dead,” but the adage does not seem to have applied in his own case. Whatever else politicians and journalists may not know about the economy, the one thing they think they know is that it is the business of government to “stimulate” the economy whenever it falters, a legacy of Keynes’s Depression-era prescriptions. That it was precisely this sort of thinking that caused most previous recessions, as central banks were forced to rein in the runaway inflation they themselves had created, is not so well remembered.

Or perhaps it is. Years of rapid growth with low inflation does seem to have inoculated us against the belief that a little more inflation will somehow lead to even higher growth, the Phillips Curve heresy that did so much harm

in the 1960s and 1970s. Outside of the Toronto Star editorial board, people do seem to have absorbed the message that the best contribution central banks can make to growth, in an economy based on price signals, is to preserve astable measure of value, and that any attempt to remedy stagnation with inflation will in the end give us only more of both.

But if we are no longer so foolish as to believe in the possibility of “fine-tuning” the economy by monetary means, that has only led to the revival of an even older piece of bunkum: the notion that fiscal policy can do the job. Hence the sudden proffering, south of the border, of a ludicrous $145-billion “stimulus” package, a mixture of (temporary) tax rebates and (probably permanent) spending increases at the

first sign of a contraction. And hence, inevitably, the call for something similar in Canada, where we have yet to see much evidence even of a slowdown, let alone recession.

I will leave it to others to point out that $145 billion, in a $15-trillion economy, is more or less a rounding error, or that the recession to which it is supposedly addressed may have long since come and gone by the time the “stimulus” is finally applied. Indeed, it may have come and gone by now, for all we know, such are the lags and imperfections in the data we have at hand. Making policy for 12 to 18 months down the road based on sixmonth-old numbers that will be revised twice may be many things, but “fine-tuning” is not one of them.

But surely the point that needs to be recalled about fiscal stimulus is that it doesn’t, urn, work. The postwar consensus in favour of deficit finance as the prescription for recession lasted precisely until it was actually tried, around the time of Nixon’s outburst. Gov-

ernments ran enormous deficits all through the 1970s and 1980s—the Ontario government of Bob Rae was perhaps the last to try the experiment—to no discernible effect.

That Keynesianism enjoyed such currency until then is not hard to explain: as Friedrich Hayek, Keynes’s chief antagonist, observed, it turned what was previously considered a vice—government profligacy—into a virtue. By spending more than it took in, two generations of economics students were taught, government somehow added to aggregate demand, rather than simply shifting the composition of it. Something for nothing, in other words.

It took 50 years of hard intellectual labour to undo Keynes’s grip. It was pointed out that much of the extra spending “leaked” out

to purchase imports; that government borrowing on domestic financial markets, by driving up interest rates, “crowded” out private investment, or if borrowed abroad, drove up the exchange rate, to much the same effect; that the recipients of tax cuts may not spend the proceeds, but save them; and that by these and other means, whatever initial “stimulus” there might be is rapidly and ineluctably unwound. In the end, there’s no free lunch, even in macroeconomics.

So far, the Harper government has been admirably unwilling to follow the Americans’ lead. Let’s hope it stays that way. The one thing the economy does not need at this point is a panicky lurch into deficit. If Jim Flaherty’s coming federal budget is denounced by the opposition as a stand-pat, ho-hum, do-nothing exercise, it will be music to my ears. The time for inaction is now. M

ON THE WEB: For more Andrew Coyne, visit his blog at www.macleans.ca/andrewcoyne