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Quote of the Day (So Far!)

Shawn Tully interviews economist Allan Meltzer.

5:39 PM, Feb 10, 2010 • By MATTHEW CONTINETTI
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Economist Allan Meltzer on what Keynes would say about the Obama administration:

Keynes didn't favor at any time that I know spending to increase consumption. He didn't want that, and in fact he believed that was taken care of by the marketplace.

Keynes wanted to increase employment by smoothing the amount of investment through the up and down parts of the business cycle. He knew that recessions cause a decline in investment, and that the fall in investment caused unemployment to rise. So he wanted the government to stabilize investment through a recession.

Meltzer is no polemicist. He's a noted professor and author of a two-volume history of the Federal Reserve (I hear the first volume ends in a cliff-hanger!). Take him seriously. Reporter Shawn Tully then asked Meltzer what Keynes would have thought about the difference between tax cuts and government spending:

Again, he was extremely vague. On spending, he did say that deficits should be temporary and self-liquidating. He clearly did not advocate long-term spending in excess of revenues, since that causes structural deficits. Nor did he specifically recommend tax reductions for individuals or companies. Those types of cuts, however, are an obvious way to achieve his goal of boosting investment in a recession. And it's been used with great success by his Keynesian disciples. For example, the Kennedy Administration tax cuts were championed by Keynesian economists, and proved very successful at raising investment.

And one of the leading Keynesians, Franco Modigliani, developed a theory of consumption stating that temporary tax cuts are mainly saved or used to reduce debt. Milton Friedman, the ultimate champion of free markets, independently developed an alternative model that came to the same conclusion. The temporary reductions under Carter, George W. Bush and Obama were all failures, since people spend more only when they're confident their take home pay will rise permanently.

This is standard economic theory that the current administration ignores.

The third stimulus bill (the first was under Bush in 2008) now under consideration in Congress is loaded with the temporary tax reductions that have had little effect in the past. Ask yourself: What if the debt-financed trillion-dollar spending bill had been a debt-financed trillion-dollar payroll and corporate tax cut instead? Would that have done a better job at spurring private investment? Obviously, there's no way to know. But across the board cuts did work for Kennedy and Reagan.

Keynes is back in fashion, so it's important that we understand what he was saying. A brilliant and prolific man, he produced an immense body of work that is filled with apparent contradictions and errors (he was still mortal, after all). I recommend Robert Skidelsky's Keynes: The Return of the Master if you want to learn more about Keynes. Also try Keynes's own Essays in Persuasion. Both offer plenty of food for thought on wintry (or summery!) nights.

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