Perhaps the fundamental problem with economics is that the numbers only get you so far.  There comes a point where empirical testing cannot prove or disprove economic claims.  Instead, ideology acts as the final piece of the macroeconomic puzzle – the point where the various schools part ways.  When it comes to depressions, economic liberals see them as demonstrative of capitalism’s inherent flaws, while conservative economists see them as the product of unnecessary governmental intrusion into the market.  This leaves both Washington and the public without any real confidence in their understanding of how the economy works, since almost any economic explanation or claim can be rebutted by an opposing school of thought.  All of this has contributed to the public’s confidence in the trade dwindling to a historic low.  In the words of the Economist, “an arrogant profession has been humbled.”

Yet, as is often the case in depressions, there may be a silver lining.  The current condition has already encouraged some of the most loyal free market economists to begin to think outside of the box.  For example, Ben Bernanke supports the economic stimulus – a program that is straight out of the Keynesian playbook.  He seems to have come to terms with the fact that monetary policy alone is not enough to bring a country out of depression.  In light of the government’s action during both the Great Depression and the current crisis, one must conclude that a more active role for the government in filling the void left by falling demand during severe economic downturns is essential, and seems to suddenly emerge as a unifying notion between the historically warring economic sects.

The danger, of course, is the replacement of one evil with another.  If Keynes blindly becomes the heart of American economic policy, then another economic calamity may well await us once we dust ourselves off from the current mess.  The trouble with societal shocks as significant as the one we are in is that it has the potential to shift the pendulum too far in the opposite direction.  Nobody wants to be too close to a source of distaste.  And the speed of the economic profession’s shift from free market principles to Keynes might prove that the intellectual underpinnings of the profession are unstable.  If they are unstable, then they’re capable of being pushed and pulled by changing tides.  Both the public and Washington must dispassionately come to terms with economics.  We cannot substitute the exaggerated virtues of free market economics with a blindness to its benefits.

Unified action during severe economic downturns is only one piece of “Milton Keynes.”  The true test of lessons learned may not come for decades – when the next asset bubble begins expanding.  Will future administrations ride the next bubble in the hopes of maximizing the political advantage that comes with economic prosperity?  Or will they have the foresight necessary to sacrifice immediate prosperity for long-term stability?  The idea behind Milton Keynes is the decreased reliance upon outdated ideologies and the rediscovery of economics as a non-partisan tool of decision-making, the principles of which appeal equally to all parties.  After all, no party has an interest in seeing its policies create economic instability.  And the entire country has an interest in Washington relying less on ideologies and partisan interests and more on the science of economics as evidenced by the past.

This article was related to the news that stimulus projects were coming in below budget and ahead of schedule.  With the economy in bad shape, this makes some sense as costs have naturally decreased and have come in lower than expected.  However, this will create the “problem” of not spending all of the stimulus money that was originally allocated.  Krugman’s solution to this is to bring back a quote from Keynes, the 1930’s economist, who proposed people do the useless work of “digging up jars full of money”:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

The theory here is that paying people to do this work would be better than doing nothing, and would get money into the system helping to stimulate the economy.  I do believe in some economic benefit from spending money via a stimulus package during a downturn, although I think the true amount of help to the economy is rather small and is currently over estimated.

The Keynes multiplier theory states that for every dollar the government spends, 1.x is gained in economic activity.  The reason I don’t believe in high “multiplier” numbers that the president and his advisers are putting out there (I think a 1.57X multiplier was the latest number used) is that there is really no proof that this theory has ever worked – anywhere in the world at any time that it has been tried.  The counter argument to this is always that the “stimulus package was not big enough”, which of course I also don’t believe.  At the end of the day you end up like Japan in the 90’s, with lots of bridges to nowhere and still a below average economy.

The logical conclusion of this “multiplier” theory would be why not spend even more money and completely remove unemployment forever?  If we have a magic perpetual motion economic machine that can create more economic activity than it costs, why not spend trillions and have unemployment disappear forever?  In reality, I think the multiplier theory only works to a small degree if the government is doing useful work (fixing roads, building bridges that need to be built, etc.) with the money it spends.  If the government starts spending on useless stuff then the number becomes less than 1.x, and takes away from future or current productive work.  The other question to this theory is – what happens to these jobs when the stimulus money inevitably stops?

We have to remember that government does not create any wealth, it can only take it from these places:

1. Tax current people (current taxes)
2. Tax future taxpayers (deficit spending + interest)
3. Print money (inflation, which taxes everybody)

The Keynes multiplier theory is somewhat valid, but only if the money is spent on useful, practical, and needed things the economy needs.  The part where I think his theory falls apart is where Krugman thinks that it’s a good idea to pay people to do useless work, “just to get the money out there”.  We always have to remember that money to pay people to do useless work comes from one of the above areas.  There is no “free lunch”.

Paying people to dig up money that somebody else has buried is useless work, and can’t possibly help the economy.  It’s simply against common sense.  However, I have not won the Nobel prize in economics, so I could be wrong.