I swear, Milton Friedman is spinning in his grave...
The debate over at the website of The Economist is even more horrifying than I thought it would be, as Luigi Zingales simply does not appear to have thought any of the issues through at all. I think that his views are what Steve Sheffrin calls the product of knee-jerk pre-theoretical Austrianism--but it is very hard to tell.
For example, Luigi Zingales:
With zero personal saving and a large budget deficit the Bush administration has run one of the most aggressive Keynesian policies in history. Not only has adherence to Keynes's principles not averted the current economic disaster, it has greatly contributed to causing it. The Keynesian desire to manage aggregate demand, ignoring the long-run costs, pushed Alan Greenspan and Ben Bernanke to keep interest rates extremely low in 2002, fuelling excessive consumption by the household sector and excessive risk-taking by the financial sector. Most importantly, it has been the Keynesian training of our policy-makers that has led them to ignore the role that incentives play in economic decisions. The main difference between Keynes and modern economics is the focus on incentives. Keynes studied the relation between macroeconomic aggregates, without any consideration for the underlying incentives that lead to the formation of these aggregates.... The current crisis is not a demand crisis, it is a trust crisis. Bad corporate governance coupled with bad government policies has destroyed the financial sector, scaring investors and freezing lending. It is as if a nuclear bomb had destroyed all roads in America and we claimed that to alleviate the economic impact of such an event we should invest in banks. It is possible that eventually the effect will trickle down. But if the problem is the roads, you want to rebuild roads, not subsidise the financial sector. And if the problem is the financial sector, you want to fix this and not build roads.
As you all know by now, I have four problems with this:
The first problem, of course, is Zingales's characterization of Bush administration economic policy as "Keynesian." John Maynard Keynes would certainly not The essence of Keynesian policies is not running big budget deficits--Keynesians call for big budget surpluses in boom years. The essence of Keynesian policies is using monetary policy and the government deficit as balance wheels to try to keep the flow of total nominal spending stable. And, yes, it does surprise me that Luigi Zingales does not seem to know what Keynesianism is.
The second problem, of course, is the characterization of Bernanke and Greenspan as "Keynesians" actively managing aggregate demand in 2002. They would say that they were, rather, monetarists--and Greenspan would especially protest extremely strongly that he was no Keynesian but rather a Randite. They would say that they were trying to keep a stable environment for private decision making by following Milton Friedman's monetarist instruction to keep the nominal money stock growing smoothly in order to keep nominal spending growing smoothly. And, indeed, they did pretty well at that task:
You can argue that Greenspan and Bernanke should have slammed on the monetary growth breaks in 2002 and 2003. But it is hard to see why. Why would one would have wished to sharply slow the rate of growth of nominal monetary aggregates back then? Inflation was not increasing, and neither equity nor housing prices in 2002 appeared to be at irrationally exuberant levels.
You have to think that Zingales simply does not know what he is talking about--does not remember what the situation in 2002 was, and did not bother to go back and look at the data.
The third problem, of course, is Zingales's claim that "Keynesian[s]... ignore the role that incentives play in economic decisions." To which one can only say, "Huh?" Keynes's analysis of liquidity preference was among the very first successful discussions of incentives to hold money, and thus of the demand for money, in economics.
And, fourth, I cannot help but be very disappointed at Luigi Zingales's claim that the "current crisis is not a demand crisis, it is a trust crisis..... It is as if a nuclear bomb had destroyed all roads in America and we claimed that to alleviate the economic impact of such an event we should invest in banks... if the problem is the roads, you want to rebuild roads, not subsidise the financial sector. And if the problem is the financial sector, you want to fix this and not build roads..." This appears to me to miss the point entirely. The banking system is broken. That is crisis 1. The breakdown of the banking system has produced a collapse in private spending that is sending unemployment into the sky. That is crisis 2. The question is: Should the government boost its spending to fill the gap and keep the unemployment rate from spiking quite so high? The answer is: Yes. But Zingales misses all this.
Thus, as best as I can tell, Luigi Zingales's argument comes in four steps:
- Our problem is in the banking system.
- Keynesian deficit spending will not fix the banking system.
- Keynesians say that even though Keynesian deficit spending will not fix the banking system, it will keep unemployment from rising much higher while we do other things to fix the banking system.
- The weakness of this Keynesian argument is--LOOK!! THERE IS HALLEY'S COMET!!!!
So it is kind of hard to figure out how to respond.
The current crisis started as a trust crisis, but has now generated a demand crisis as well--and the fact that we need to fix the first does not mean that we should do nothing to fix the second.