Keynesian Economics vs. Austerity

With hope on the horizon, the world is slowly beginning to come out of the shadows of what many have dubbed, The Great Recession. Unlike the past depressions and recessions of history, the world now finds itself inexorably linked to the conditions and fickle ups and downs of the great economies of the West and the East. Not even China, with its booming manufacturing and commodities sectors, was able to weather the storm unscathed completely.

The economic chaos has scattered panic, mud-slinging, and hastily proposed policy changes out of the countries struggling to pull themselves from what is arguably the greatest financial crisis the world has faced to date. Emerging from these new policies and debates is the age-old question of austerity vs. stimulus, otherwise known as the great debate between Keynesian theory, and so-called free-market economics.

Greece may be the most volatile and poignant example of just how impactful these disagreements can be. Though the political and economic landscape in Spain, England, Greece, and numerous other countries remain in utter turmoil over which of these very different philosophies should be followed, the United States also remains high on the ridiculous rhetoric and general polarization scale. At least Greece makes decisions, riots notwithstanding.

In the United States, you could fairly easily frame this discussion as Republicans (“fiscal conservatives”) VS. Democrats (“big government”). The polarization in the U.S. Congress is largely a direct result of the two primary parities having built economic ideologies around the differences between traditional economics, and Keynesian economics.

Simply put, the Keynesian Theory of Economics is a macroeconomic theory that states that the demands for goods and services in the private and public sectors are the primary driver of any country's economy and that the government should step in and increase demand during a slump. This increase in demand is achieved via a stimulus package. Keynesian economists believe that if demand is artificially increased, spending will increase. This, in turn, causes increased demand, thus creating new jobs to meet this increased demand. In theory, this will allow the economy to level off over time without noticeable negative effect.

Keynesian economists also believe strongly in the multiplier affect condition. Simply stated, this is the belief that if one spends “x” amount of dollars, someone else will take those dollars and spend them with additional monies, thus multiplying the funds and their usefulness by pumping them back into the economy plus additional funds.

The Keynesian school of thought is directly counter to what Keynes referred to as the orthodox economic viewpoint, whereby only the private sector acts as a driver without any significant governmental contribution necessary to increase demand. This traditional economic viewpoint maintains that austerity, or severe cuts in spending as to reallocate funds to the respective country's deficit, should be the primary driver in pulling an economy out of a recession.

The idea behind  austerity call for the immediate reduction in spending by the government during difficult economic times so that private citizens and businesses will see this as a secure promise that their costs will decrease, allowing them to maintain or increase their own spending. Unfortunately, these cost-cutting measures are provided at the expense of government programs and services that benefit the population as a whole. Austerity proponents seem to forget that a larger percentage of the population requires assistance during a recession, without which their spending lessens even further.

John Taylor, Standford University professor and former economic adviser to the Mitt Romney campaign, further details the primary concerns that many anti-Keynesian economists voice with relation to recession economics in a 2012 CNN Money interview by Janice Revell. Taylor states, “The stimulus increased the federal debt burden and created uncertainty about what was next for taxpayers Households mostly saved the stimulus money instead of spending it.” (Revell, 2012).

Like Taylor, many argue that Keynesian spending policies create instability within the psyche of the citizens of the country in question, thus causing them to hoard any additional monies they receive canceling out the increased spending that is supposed to occur with a stimulus package. This, in turn, slows growth.

This line of thinking is not incorrect in its assertion that increasing the national debt, which will force a tax or other means of governmental income collection down the road, could potentially be damaging. However, proponents of austerity seem to have forgotten that we all now function in economies in which businesses have been able to grow so large that their failing has an immediate and devastating effect on their respective economies. Because of the nature of modern global economics this, in turn, dominos onto the world stage affecting multiple countries and their populations.

Can we, indeed, live in a world without some form of bailouts, and stimulus e.g., Keynesian economics? The answer is no since this is simply no longer a plausible solution based on the economic structure built in the United States and others countries built around the world.

The 2008 financial bailouts of banking and automotive industries, as well as food stamps, are prime examples of these Keynesian principles in action that traditionalist fear. In a Wall Street Journal article, Harvard economics professor Robert Barro (2011) quoted Agriculture Secretary Tom Vilsack, illustrating the multiplier principle. He noted, “For example, in true Keynesian spirit, Agriculture Secretary Tom Vilsack said recently that food stamps were an 'economic stimulus' and that 'every dollar of benefits generates $1.84 in the economy in terms of economic activity."

Barro also goes on to disagree with the entire notion of the idea which Secretary Vilsack had put forward, and Keynesian economics as a whole...and he has a point. Not everything about Keynes's theory is sunshine and roses during a recession, pretty much like any other theory put into practice. Spending money and increasing debt does carry with it a significant risk of slowed growth.

I'm inclined to disagree with Barro; however, one needs to look no further than our own current economic direction at the end of 2012 to see why our government's current Keynesian approach to the economy is stepping in the correct direction.

According to a CNN Money article by Annalyn Censky (Censky, 2012), immediately after Obama taking office the U.S. economic growth rate was -5.3%, however, was showing overall growth within months of the initial stimulus package, and has continued to grow every year since that time. The economy is also on target to reach its necessary 3% growth rate to combat unemployment, though unemployment has already fallen to pre-Obama levels (Censky, 2012).

Additionally, as of July, Censky also reported Business spending up to a 7.2% annual rate; he also emphasized on increases across the board in big ticket items such as automobiles (Censky 2012). The bottom line: the economy has been trending upwards since before the end of 2009.

Sadly, there is also a bottom line with regards to austerity. Austerity during a recession produces exactly the result that, according to its champions, will occur with Keynesian stimulus. Less assistance produces less spending to ensure basic needs can be met is its basic. It also protects the largest and most able institutions and private citizens, while the rest potentially have a reset button turned on them, so to speak.

Austerity belongs in prosperous economies, not damaged ones. The economy may not recover under a stimulus package as quickly as many would like; however, in a world where we are all economically tied to one another across the globe, what exactly should be the expectation?

There is no immediate and easy fix to economic crises. There is, however, a logic-based approach, and an approach that appears to be mostly based in maintaining one's ideological beliefs about the role of government. At the end of the day, as with any policy, philosophy, or law, its successful execution depends a lot on who is behind the wheel.

Is Keynesian economics exclusively the answer? No, I do not feel anyone might successfully argue that. Can anyone argue that policies of austerity are the sole answer to fiscal crisis? No, I do not believe anyone could stand behind that either. Neither school of thought should be considered exclusively when dealing with a present crisis. In my opinion, a blending of the two - with emphasis on stimulus - must be sought to bring the most expedient resolution possible.

Order now

Related essays