Free Article Review On Barack Obama’s Keynesian Mistake

Summary/analysis

Ike Brannon and Chris Edwards argue that President Obama’s economic stimulus package was a mistake and that it has no impact on the long-run economic growth (Brannon & Edwards, 2009). They argue that macroeconomic research shows that the plan by federal policy makers to use a substantial $800-billion stimulus package will not succeed in returning the economy of the US to growth. They further argue that Keynesianism is old-fashioned, and its revival arises from political expediency and not from historical experience or modern economic theory. According to the Keynesian theory established by John Maynard Keynes in the 1930s, government intervention can revive the economy during times of economic downturn. Fiscal policy interventions through manipulating spending and taxation can increase aggregate demand thus returning the economy to growth and reducing unemployment.
The effectiveness of the Keynesian policy was challenged during the Great Depression when the economic downturn lasted long. Keynes argued that it was because of the sticky wages, among other problems that barred the economy from returning to full-employment equilibrium. However, Keynes did not prove that the stick wages was a serious problem, and further research indicated that wages fell during the period. Keynesian economics believed that there is a tradeoff between unemployment and inflation and that the government can apply fiscal policy measures to increase aggregate demand (Gwartney, Stroup, Sobel & Macpherson, 2010). For instance, an increase in government expenditure and a reduction in taxes would increase aggregate spending. However, a reduction in taxation increases disposable income thus causing demand-pull inflation (Mankiw, 2014). Keynes argued that fiscal stimulus would solve the problem of sticky wages by fooling workers to accept lower real wages during inflation. This is not feasible as employees are rational hence they cannot accept any decisions that leave them worse off.
Individuals and businesses are rational and base their decisions on the future. They, therefore, adjust their behaviour whenever there is fiscal stimulus plans by the government. In the 1970s, the effect of this was felt when the increased government spending and tax deficits did not reduce unemployment but only caused higher inflation. A research by Milton Friedman, a monetarist, indicated that the Great Depression was aggravated not by the private market’s failure but by the inefficiency of government monetary policy. The idea of government stimulus may be good, but it is not always implemented in the right way. The Keynesian approach can only work when policymakers recognize economic problems early enough and quickly establish strategies to counteract the challenge. Past stimulus actions in the US, however, have been ill-time with motives other than the public interest advocated by the Keynesian theory.
In the 1970s, the old-fashioned Keynesian theory was replaced by the ‘rational expectations theory.’ The rational expectations theory was developed Robert Barro, Thomas Sargent, John Muth, among other economists. This revolution has led to a shift from the old-fashioned manipulation of short business cycles to studying the aspects of long-run economic growth. In 2008, there was intense lobbying for the approval of the $170-billion stimulus, without any consideration for the long-run growth. It turned out to be ineffective as it only increased federal debt with minimal positive effects (Krugman & Wells, 2009). Brannon and Edwards reiterate that the impact of the 2008 stimulus package should be a lesson to politicians and macroeconomics to be more skeptical in analyzing macroeconomic policy actions. Most economists have been surprised by the $800-billion stimulus plan. This has been challenged by many analysts who believe that Keynesian ideas no longer have a place in modern economics. They disagree with Obama’s claim that the stimulus will create four million additional jobs. President Obama has no proposals for the long-run fiscal changes just like President Bush. According to University of Chicago’s John Cochrane, Keynesian economics is nowadays taught in universities only for its flaws.

References

Brannon, I., & Edwards, C. (2009). Barack Obama's Keynesian Mistake. Cato Institute. Retrieved 22 April 2015, from http://www.cato.org/publications/commentary/barack-obamas-keynesian-mistake
Gwartney, J., Stroup, R., Sobel, R., & Macpherson, D. (2010). Macroeconomics: Private and Public Choice (13th ed.). New York: Cengage Learning.
Krugman, P., & Wells, R. (2009). Economics. New York: Worth Publishers.
Mankiw, N. (2014). Principles of Microeconomics. Melbourne: Cengage Learning Australia.