Economists from Larry Summers to Paul Krugman are discussing the new phenomenon of “secular stagnation,” meaning our economy has entered a period of long-term stagnation due to depressed aggregate demand. They claim we need more government spending to fuel demand and jump-start our economy. But these Keynesian policy prescriptions miss the point, and in fact, similar policies pursued for the past decade are what got us here.
Going back even further, they were tried before in the Great Depression. In 1929, the market crashed and the federal government, led first by Hoover and then by FDR, tried to stimulate demand to cure the depression. Hoover launched a small stimulus package. FDR’s New Deal spent billions trying to put the entire nation to work to boost demand. But far from ending the depression, government intervention made the situation worse. Professors Cole and Ohanian, writing in the prestigious Journal of Political Economy, argue that, “New Deal labor and industrial policies … prevented a normal recovery.”
In FDR’s Folly, Jim Powell argues that the New Deal created business uncertainty and burdensome new regulations, and this together with more government spending kept the economy in a rut. FDR’s anti-business policies kept output low and unemployment artificially high: in the entire 1930s, unemployment never fell below 14 percent. Indeed, according to Cole and Ohanian, FDR’s disastrous policies prolonged the Great Depression by 7 years. By 1939, even members of FDR’s cabinet admitted that they had badly erred. Henry Morgenthau, FDR’s Secretary of the Treasury, admitted that government spending didn’t work. “After eight years of this administration we have just as much unemployment as when we started … and an enormous debt to boot!” Government spending extended the depression and created an economy where depression was (temporarily) the new normal.
Today, we see the similar policies and similar effects. The economy crashed in 2009, and Keynesian policies once again ascended. Congress passed a $831 billion stimulus, the largest in history, in 2009. The Federal Reserve has enacted rock-bottom interest rates and still prints around $85 billion per month.
These are all policies right out of the Keynesian playbook. The stimulus, while not as large as men like Krugman wanted, should have — according to Keynesian models — boosted demand and created a multiplier effect to rebound the economy. The Federal Reserve’s aggressive policies of low interest rates and monetary expansion should have promoted investment and lending by banks. Krugman praised the Federal Reserve’s actions in particular, saying there was no-one besides Ben Bernanke he’d rather have at the helm of the central bank.
For the past five years, Keynesian economists have more or less had their way in both Congress and at the Fed. And yet, their policies have led to what they themselves call stagnation. The economy’s operating at about 10 percent (or $1.6 trillion) below its predicted potential, as judged in 2007 by the CBO. As economist Robert Higgs points out, employment hasn’t even returned to 2007 levels. After 5 years of Keynesian policy, unemployment is still high and output is still low.