Keynes was right: increased government spending in the U.S. is necessary to decrease unemployment and raise demand in the near-term.
Paul Krugman hardly needs defending, but his views about the need for Keynesian stimulus in the U.S. right now are coming under considerable fire from centrist and left-of-center economists. I find this disturbing because Krugman’s view abides by basic Keynesian principles that seem to have been discarded by many who profess themselves Keynesians. Is there a wide misunderstanding of Keynes?
What seems to upset people is that Krugman argues the government must spend more money now, almost regardless of what it spends it on. The Keynesian thesis is that economies can settle at a high level of unemployment rather than re-adjust to the optimum unemployment level—or level of economic activity—on their own. This was a response to the classical, pre-Depression view that the beauty of free markets was a self-adjustment process based on falling prices in downturns. But ultimately the problem is a lack of demand, and Keynes advocated budget deficits to support an increase in demand.
The lack of demand in the economy now is palpable. Krugman’s contention is that in the near-term, we can solve this problem if we have the will to do so. The economy can reduce its rate of unemployment fairly rapidly with adequate Keynesian stimulus. It is clear that monetary stimulus at this point is not enough.
This view is not incompatible with longer-term concerns about the economy -- inadequate education for too many, infrastructure decay, old energy technologies, and so on. Many seem to criticize Krugman for not acknowledging “structural” changes in the economy, and they implicitly agree with classical conservative observers that the unemployment rate really can’t fall much below 7 percent. I can’t speak for Krugman, but he seems to be saying that we should not mix up longer-term structural issues with near-term demand inadequacy. It’s very likely the unemployment rate can fall much farther without igniting inflation.
I can’t see how he is wrong about this; indeed, he is urgently right about it. We are facing a year or two when the federal government will likely contract spending and will certainly not increase stimulus markedly. Of even greater concern is the refusal in Europe to recognize that austerity—the opposite of Keynesian advice right now—will lead to further recession, which in turn could spill over to the U.S., jeopardizing Obama’s candidacy.
When so many commentators criticize Krugman’s view, insisting that any new spending must be investment in infrastructure, must not go to the military, or that there should be no new spending at all, they are ignoring the Keynesian process. Krugman will not advocate against military spending cuts (and I certainly wouldn't myself). But priorities are important here. Let’s keep them clear.
In sum, let’s understand that more aggregate demand now will reduce the unemployment rate. There is a near-term solution, not to America’s long-term issues, but to an economy that is sputtering and may lead to a political environment in which those who plan to do more damage win office.
One of the true advances in contemporary thinking is that both a power and a duty of government is to use fiscal and monetary policy to ameliorate downturns and create economic expansions. This is the legacy of Keynes, well supported by empirical research.