Yesterday I had to run before finishing my post on Brad DeLong’s piece for The Week titled, “Keynes and Co. have lost the stimulus argument.” DeLong and his fellow Keynesian Paul Krugman have been wringing their hands of late with worry that policymakers in the White House, Congress and the Federal Reserve are losing faith in their religion of huge deficits and money-printing. I think their concerns are exaggerated — the president of the United States was recently seen urging Europe not to turn off its stimulus machine just yet — but for the sake of argument, let’s say they’re right, and the Keynesians have lost the debate. Why might that be? Yesterday I ran through a few of Krugman and DeLong’s proffered reasons, which I didn’t find persuasive. Here are some alternative theories:

1. The stimulus didn’t work. Right now, Democrats in Congress are having trouble getting the votes for the latest stimulus package, but if it passes, we will have spent more on fiscal stimulus since 2008 than we have spent on the wars in Iraq and Afghanistan since 2001 (see my latest piece in NRODT for the numbers breakdown). Now, spending nearly a trillion dollars on fiscal stimulus might have prevented the recession from being deeper and mitigated job losses somewhat, but it also might have slowed the recovery by A) creating the expectation of higher taxes in the future and B) preventing the economy from finding a bottom, from which point I’m pretty sure investors could have found better things to do with that trillion dollars than the U.S. government. Keynesian stimulus is all about mitigating the short-term severity of recessions, but in so doing it creates all kinds of valuation problems — idle resources stay idle because private investors are waiting for bargains. Government borrowing and spending distorts values throughout the economy and locks up capital in bad investments, so that less money is available when good investments start to emerge.

Nowhere has this been more evident than with regard to the Homebuyers Tax Credit. The $8,000 credit was intended to stimulate demand for housing and keep prices from falling. Every day since its expiration in April, we’ve been getting more evidence that we spent in the neighborhood of $15 billion just to delay the day of reckoning by a year or so. Here’s the latest, from the Boston Herald, via Calculated Risk:

There’s a silver lining for would-be home buyers who missed the April 30 deadline for the $8,000 federal tax credit: Sellers are dropping prices.
The average price reduction for a single-family home or condominium in the Bay State last month was 8 percent, or $38,883 off the original asking price, according to real estate search engine Trulia.com.
In Suffolk County, which includes the cities of Boston, Chelsea, Revere and Winthrop, the price reduction was $43,288, or 7 percent off the listing price.

Krugman and DeLong argue that the stimulus simply wasn’t big enough. Convenient argument, that. Impossible to falsify. The fact remains that the four stimulus bills we’ve passed since early 2008 have failed to deliver the sustainable economic growth and job creation their proponents promised. The president’s economic team predicted that the stimulus would hold unemployment at 8 percent. It is currently at 9.5 percent and stuck there, not sloping off as the president’s team predicted. I don’t know for sure, but maybe that’s why Keynes and Co. have lost the stimulus argument.

2. The Keynesians got us into this mess. At least that’s what the arguments advanced by Stanford economist John Taylor lead us to conclude. Taylor has persuasively argued that the Federal Reserve took Keynesian monetary stimulus too far in an attempt to fight the recession that followed the collapse of the dot-com bubble. Taylor is the author of the Taylor Rule, which sets reasonable parameters for central bank interest-rate policies. As Taylor explained last January:

My critique… is based on the simple observation that the Fed’s target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom. The deviation from the Taylor rule, which had characterized good monetary policy during the previous two decades, was the largest since the turbulent 1970s.

At the time, Keynesians such as Paul Krugman were cheering the Fed on. With their short-term focus on mitigating the short-term effects of recessions, they ignored the larger threats, even when cognizant of them. Here are a few choice observations and arguments Krugman made at the time, as compiled by Mark Thornton:

May 2, 2001: “However, let’s give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed’s four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It’s still not clear that Mr. Greenspan has caught up with the curve — let’s have at least one more rate cut, please — but the interest-rate cuts do, cross your fingers, seem to be having an effect.”
August 14, 2001: “Consumers, who already have low savings and high debt, probably can’t contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery… But there has been a peculiar disconnect between Fed policy and the financial variables that affect housing and trade.”
October 7, 2001: “In time this overhang will be worked off. Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. But it seems inevitable that there will also be a fiscal stimulus package.”

And of course, who could forget:

August 2, 2002: “To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”

Now, I am willing to subscribe to Arnold Kling’s generous interpretation of this quote, which is that Krugman was “not cheerfully advocating a housing bubble, but instead he was glumly saying that the only way he could see to get out of the recession would be for such a bubble to occur.” However, it remains the case that Krugman and other Keynesians were calling for rate cut after rate cut, even after prudence (i.e. the Taylor Rule) suggested that the Fed had ventured into risky territory and was on the verge of doing just what Krugman predicted it might need to do to “fight this recession” (i.e. create a housing bubble).

The broader takeaway is that, with their short-term focus, Keynesians are insufficiently attuned to or concerned about the longer-term risks associated with the policies they support. They are very proud of this short-term focus and see concern about the long-term effects of their policies as a sort of cop-out. As Megan McArdle put it:

Of course, we do not yet have uncontrolled inflation (or really, any sort of inflation) in the United States. And demand for US debt remains robust. So why wouldn’t we try more stimulus?
That’s a plausible argument. But you have to balance it against another plausible argument, which is that all the countries who are now in trouble were once countries who found themselves able to borrow at surprisingly attractive rates. In fact, due to external market conditions, these rates were actually often somewhat lower than they were used to paying. This did not end well.
Austerity is an expensive form of insurance against a true fiscal crisis.

To keep with the metaphor, DeLong and Krugman don’t think we need that insurance. They don’t even think we need to be careful drivers. To top it off, as discussed above, they don’t have the greatest track record behind the wheel. And they’re surprised that the public seems less inclined to take their advice? I’m not.