Advantage: Keynes?

06/01/2011 10:02 am ET | Updated Aug 01, 2011

If you want to know what is going to happen next to your investments, the job and housing markets, and more generally to the economy, you may want to follow what is happening to the ideas of British economist John Maynard Keynes. Keynes argued that when economies are sputtering, the government must increase deficits, because its increased expenditures will stimulate the economy to better growth. (The time to slash government spending is when the economy is running at full clip.) This is the theory Presidents Bush and Obama, as well as the Federal Reserve, have followed. However, the anti-Keynesians have long maintained that cutting government expenditures is the course to follow -- because the more money that is left in private hands, the better for the economy. The Tea Party is full of anti-Keynesians, and these days, so is the GOP leadership in Congress.

Recently in Europe, the anti-Keynesians seem to have won a round. When the conservative-led governments in the UK and Germany curtailed government spending and announced more cuts (note: the market is affected by what investors expect to happen next), the two countries' economies grew. Britain's government released an "austerity budget" of deep cuts, and soon thereafter (in the third quarter of 2010), its economy grew by 0.8%, surpassing predictions.

Similarly, by late summer of 2010, after German chancellor Angela Merkel announced nearly $100 billion in cuts from the budget by 2014, the economy was growing at a 9% annual rate, and unemployment had fallen to pre-crisis levels. In the Weekly Standard, Christopher Caldwell argued that the German results showed that "something in our economic dogmas is probably false." David Brooks proclaimed that the "early returns" of the "natural experiment" comparing American and German approaches suggested that the German approach was the correct one.

These observers uncorked the champagne too early. Both economies are now sputtering. In January 2011, the British government released figures showing that the economy had contracted in the fourth quarter of 2010, defying predictions of growth and reigniting fears of a "double-dip" recession. In April, the IMF downgraded its UK growth forecast for the third time in a year. And in Germany, previously-rapid growth has slowed significantly, although it seems to be regaining speed in the last quarter.

Meanwhile, in the U.S., the federal government has started cutting expenditures, and investors hear daily about many more cuts to come. Local and state governments are slashing their expenditures. The Federal Reserve is about to end the main part of its stimulating program in June. And U.S. economic growth slowed down from 3.1% at the end of 2010 to 1.8% at the start of 2011. Another round for the Keynesians.

Surveys reveal that economists tend to agree that the American economy will pick up pace again over the next months. If so, the anti-Keynesians will find a data point to support their agenda of more and bigger cuts in government expenditures. However, do not bet your last dollar on these predictions. At best, the economy may well continue merely to sputter along, growing a bit faster than in the first quarter, but still at a rather sluggish pace. In this case, the main point will not be that the Keynesians will win one more round -- but that we are following a wrongheaded economic policy that will cost us all plenty.

As I see it, Congress and the White House would best now commit themselves to major deficit cutting measures -- to be automatically triggered only once unemployment falls below 7.5% or some such figure. This should be a policy both Keynesians and the anti-Keynesians could learn to love.

Amitai Etzioni is a University Professor at The George Washington University and the author of The Moral Dimension (The Free Press, 1988).