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Affluent Investor | July 27, 2017

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If Keynesianism Worked, The Great Depression Would Have Been a Short Depression

John Maynard Keynes

During the years of the Great Depression, John Maynard Keynes formalized what he called his General Theory of Employment, Interest, and Capital, which heavily influenced politics of the time and the development of economics in subsequent decades. He is often characterized as the man who single-handedly prevented the collapse of capitalism under its own weight, thus “saving capitalism from itself.”

Recessions and depressions are a time of less than full employment, when the economy is performing well below its potential. According to Keynesian thinking, employment comes from people buying things, and during an economic slowdown, people buy less, for whatever reason. People buying less means that there is less demand for products, and that leads to laying off workers to cut costs and prevent losses for businesses.

The Keynesian view is that, if the market does not demand enough to keep full employment, it is government’s job to take up the slack. Promoters of government intervention often regurgitate something like the following: “So, there needs to be some centralized economic authority with access to money who is legally bound to spend it at those times. Otherwise boom and bust cycles are more extreme and long-term economic growth is reduced.” As uber-Keynesian economist, Paul Krugman, put it: “Slashing government spending in a depressed economy depresses the economy further.” It is the idea embedded in the policies of monetary and fiscal stimulus, or pump-priming, that has dominated economic policy-making and central banking.

With any scientific explanation of a phenomenon, if there is one case that doesn’t fit, it falsifies the theory. With that in mind, Keynesian sympathizers must explain the depression of 1920. It was deeper and more severe than the 1929 depression. The 1920 event, as with most economic downturns prior to it, was met with the opposite of Keynesian stimulus. Government spending, debt, and taxes were all cut significantly, but rather than depressing the economy further and making things worse, the benign neglect from politicians resulted in a quick recovery, with the economy going strong after only eighteen months.

It is certainly true that the 1929 depression turned into the Great Depression for more reasons than Keynesian policies. Politicians, most notably Presidents Hoover and Roosevelt, however good their intentions, did things that twisted the economy in knots and destroyed regular economic incentives, cutting the legs off of a relatively normal recovery in the early 1930s. With that said, however, the entire program for recovery was government intervention into the economy to stimulate it through various means. As it turns out, almost all of those programs and policies hurt real people and prevented recovery rather than stimulating it.

It is quite ironic that many Keynesians and government interventionists point to the Great Depression years as a golden era, saying that the economy recovered with all of those programs in place, so they must work. They fail to explain, however, why, with all of the stimulus and intervention, the economy took well over a decade to recover when most prior depressions without such interventions were over in one to two years. They fail to explain why they ignore the 1920 depression when it sets an example for a recovery done right, with very good results.

The economics profession has, to a significant extent, unfortunately, become an arm of politics. Mainstream economists like the spotlight and fame, and have become important players and cheerleaders in the political game as opposed to their prior role as practitioners of the “dismal science,” telling politicians what they can’t and shouldn’t do. Neither capitalism nor markets need to be saved from themselves. They need to be saved from politicians and the economists who help them to justify the damage they do.

 

Originally published on Dan-McLaughlin.com.

Daniel J. McLaughlin is the author of “Compassion and Truth-Why Good Intentions Don’t Equal Good Results.” Formerly a finance executive, he is now focused primarily on writing on economics, business, and politics. You can find him at daniel-mclaughlin.com.

 

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