Keynesian economics rediscovered
The George W. Bush administration ended with an economic disaster—the financial crisis of 2007 and the worst economic recession since the Great Depression. Two economic bubbles burst, a bubble in housing prices and a bubble in fixed-income investments, especially the derivative investments based on shaky mortgage loans. Blinder does not link these asset bubbles to Republican tax cuts, but other Keynesians suggest a connection. Paul Krugman makes a case in Arguing with Zombies that tax cuts for the wealthy have been a “fizzle” because too much of the money has gone to boost the price of existing assets instead of financing new investment.
As the financial crisis turned into the Great Recession, “policy makers all over the world turned Keynesian very quickly.” In the United States, Keynesian responses began with the Economic Stimulus Act of 2008, which sent $600 checks to individual taxpayers ($1200 to married couples). Economic leaders soon realized that it wouldn’t be enough. Treasury Secretary Henry Paulson and Fed Chair Ben Bernanke then persuaded Congressional leaders of the need for a much more aggressive program. They proposed a $700 billion Troubled Assets Relief Program to buy devalued financial assets. Much of the money was aimed at injecting capital into troubled banks. President Bush relied on Democratic votes to pass these measures, with most Republicans voting no. After President Obama (2009-2016) took over, an additional stimulus bill, the American Reinvestment and Recovery Act (ARRA), passed without a single Republican vote.
Blinder joins many other economists in crediting these measures—plus the bank stress tests, which were more regulatory than stimulative—with turning the corner on the recession. It bottomed out in 2009 and was followed by the longest expansion in U.S. history, lasting until the pandemic of 2020.
Politically, the change of fiscal policy was highly polarizing. While Democrats turned sharply Keynesian, Republicans turned sharply anti-Keynesian. After Obama took office, the Tea Party movement whipped up anti-tax, anti-spend sentiment. Its leaders were especially incensed about Obama’s relatively small program to assist homeowners facing foreclosure, despite the fact that polls found about two-thirds support for it. Republicans started describing ARRA as the “failed stimulus” even before it had time to work. After Democrats lost the House in 2010, economic policy turned contractionary, even though the still recovering economy could have used additional stimulus. After several years of anti-Keynesian rhetoric, “No politician even dared utter the word ‘stimulus’.”
With the election of Donald Trump in 2016, the policy focus turned back to tax-cutting. The administration’s arguments for it were largely divorced from any widely accepted economic theory.
Trump’s supply-side rhetoric far surpassed anything the Bush team ever dared claim. If you took Trump at his word, the tax cuts would propel annual GDP growth into the 5-6 percent range [at least double the recent rate], reduce the budget deficit, and then produce surpluses large enough to pay down the national debt. Of course, no serious economist believed those claims.
In fact, after the tax cut the recovery continued at about the same moderate pace as before, but with even larger budget deficits. Unlike previous tax cuts, these were not even very popular, since they favored corporate shareholders and other wealthy taxpayers over the general public.
The coronavirus pandemic of 2020 caused a short but especially severe recession, as it seriously disrupted economic activity of many kinds. With Trump in office, Congress responded with bipartisan support for the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the largest spending bill in history. The economy bounced back sharply by late in the year. When Joe Biden assumed office in 2021, Republicans turned against any additional spending. Biden’s American Rescue Plan squeaked through Congress with no Republican votes. One of its provisions was a larger and refundable child tax credit, available even to families too poor to pay income taxes. (It would turn out to cut child poverty from 9.7% to 5.2% in one year, but poverty went back up again when Senate Republicans blocked its extension with the help of Joe Manchin.)
Because the economy was already recovering by 2021, economists disagreed over whether Biden’s additional deficit spending made economic sense. When inflation surged in 2022, they debated how much inflation was due to excess demand, as opposed to lingering supply shortages caused by the recession. Republicans blamed the Biden administration alone, and went back to calling for deficit reduction. As usual, they meant only spending cuts, not tax increases.
Keynesian economics and political ideology
The two severe recessions of the twenty-first century—the Great Recession of 2007-2009 and the epidemic of 2020—triggered Keynesian policy responses and fostered a renewed respect for Keynesian theory. The idea that the markets were self-regulating and would quickly stabilize themselves without government intervention became less credible. “The competitors to Keynesian economics all either fell of their own weight (e.g., monetarism) or saw their most useful aspects incorporated into the Keynesian tradition (e.g., rational expectations).”
However, the two major American political parties participated in these developments in very different ways. Democrats have a long tradition of Keynesian thinking. Blinder’s list of “basically Keynesian” presidents includes five Democratic presidents—Kennedy, Johnson, Carter, Obama, and Biden—but only two Republicans—Nixon and Ford, both over forty years ago. Democrats have proved more willing to raise government spending or lower taxes with the explicit aim of increasing aggregate demand. Neither party has used spending cuts or tax increases very often to fight inflation—they have relied more on monetary policy for that—but the most successful deficit reduction program in recent memory was implemented by a Democrat, Bill Clinton, without Republican support.
For the past forty years, Republicans have simply called for less government—less spending and less taxation. That may make sense from an old neoclassical perspective, where the economy works best on its own. But the field of economics has not fully embraced that view since the Gilded Age. As Keynesian economics regains support, Republicans find themselves more and more disconnected from today’s economic thinking. To make matters worse, Republicans often fail to practice the economic theory they do preach. They overlook deficit spending by Republican administrations but deplore it by Democratic ones.
Blinder says that fiscal policy decisions are more political than monetary policy decisions, which can be more narrowly technical. Taxing and spending decisions reflect what kind of society and government Americans want. Different political parties will continue to disagree on such questions, whatever happens in the field of economics. Nevertheless, I believe that the contributions of economics can keep political discussion from degenerating into a clash of ideologies. Economists really do try to figure out how economies work, and they really do learn from experience. For all their false starts and blind alleys, economists have a better understanding of national economies than they did a hundred years ago. Some of the things they have learned lately are that aggregate demand matters after all, and that a thriving capitalist economy requires strong aggregate demand, not just an adequate supply of capital. Policies designed to give capitalists more capital to play with can lead to foolish investments and unsustainable asset bubbles.
In Arguing with Zombies, Paul Krugman used the term “zombies” to refer to “ideas that should have been killed by contrary evidence, but instead keep shambling along, eating people’s brains.” I see the persistence of economic zombies as part of a larger trend—the increasing preference of some political leaders for propaganda over facts and science. MAGA Republicans are the worst offenders, probably because what they want for the country is most difficult to defend on rational grounds. Economic literacy is part of the knowledge base that an informed electorate needs to tell the wise leaders from the charlatans and govern itself responsibly.
Beneath the Surface 