THE 'REAL' KEYNESIAN ECONOMICS

The debate has only begun on whether the various stimulus packages are enough to kick-start the economy. Of great help will be Animal Spirits, a new book by two well-known behavioral economists who study the psychological and sociological aspects of financial markets—Nobelist George Akerlof and author Robert Shiller. Professor Shiller is best-known for coining the term “irrational exuberance” in his book of the same name, which predicted the dot-com bubble bursting.

Get Reaganomics off our backs!—translated into layman’s terms, that’s how Akerlof and Shiller begin Animal Spirits (Princeton U. Press, 2009. It is an inquiry into the role of human psychology in economic behavior. The small-government, laissez-faire outlook that Reagan helped popularize has severely damaged the financial system. “Now, three decades after the elections of Margaret Thatcher and Ronald Reagan, we see the troubles it can spawn. No limits were set to the excesses of Wall Street. It got wildly drunk. And now the world must face the consequences.”

What in fact the Obama Administration is trying to do is not only stimulate job formation and retention that will in itself grow demand for more goods and services, but raise the confidence level of consumers and business as well. This is also at the core of British Lord Keynes economic theory. Keynes believed that the Great Depression was caused by a pervading loss of confidence in both business and government to correct the economic malaise of that time.

Animal Spirits cites the crash of 1929, for instance, when speculative exuberance and the narrative of a “new era” of continually appreciating stocks suddenly evaporated, while technical factors such as central bank protection of the gold standard worsened unemployment by causing a deflationary price spiral.

As Keynes pointed out, the fundamental problem was that bankers were too scared to loan, because they thought they would lose their money—sound familiar? And since none of the deficit spending was on a scale needed to stimulate demand, self-perpetuating hopelessness set in. Only with the emergency mobilization of World War II did the shattered national mood, and narrative, begin to change.

Might some parts of President Obama’s stimulus measure not work? Of course. Some economists, including Nobelist Paul Krugman, fear that not enough is being done to give it an immediate boost this time, either. Just put more money in people’s pockets, whether via rebates or tax cuts, say some. But history shows that doesn’t provide much bang for the buck. It doesn’t necessarily get consumers spending again, for instance.

Much of the stimulus spending focuses on increasing productivity and nurturing research and innovation in future technologies. Another part focuses on improving our educational and health care systems. The Congressional Budget Office predicts that the economy may need a boost through 2011, so the stimulus package is aimed at promoting a sustainable recovery, not a quick fix.

After touring through this grim history, our contemporary problems, as severe as they may be, don’t look quite so bad. Profs Akerlof and Shiller end on a reassuring note: “Yet we are currently not really in a crisis for capitalism. We must merely recognize that capitalism must live within certain rules.” And we must take into account that irrational behavior has a real effect on demand, necessitating government intervention.

Harlan Green © 2009