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NOTE Has Keynesian Stabilization Policy Actually Stabilized Output and Employment?

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Keynes recommended governments run deficits during bad times and surpluses in good times.

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The surplus recommendation seems to be largely ignored.

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The idea is that recessions happen because there's this spontaneous behavior on the part

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of New Yorkers.

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They just stop going into the Carnegie Deli and ordering tongue sandwiches, and now we

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have a recession.

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There's massive unemployment as the Carnegie Deli has to lay off its workers, and the Federal

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The Federal Government can come in and fix this by providing the City enough money to finish building the Triborough Bridge.

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Yes, that is an oversimplification, but...

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The analytical tests presented here face two main problems.

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One is that deficits may result from economic downturns either as government revenue is lost endogenously

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or because the deficit is purposely enlarged

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to combat the recession. Thus recessions may cause deficits and if this is the

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case it becomes somewhat specious

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to conclude Keynesian stabilization policy fails to alleviate recessions.

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A further difficulty is that Keynes's recommendation for surpluses in good

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times

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is never followed so we can't test theoretical Keynesianism

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only Keynesianism and practice. First we regress the unemployment rate as the

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explanatory variable and the GDP growth rate to explanatory variables on the

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deficit being explained here expressed as a percentage of GDP. The positive

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significant coefficient on unemployment means that larger deficits accompany

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Any Higher Unemployment, and this is with annual data from 1948 to 2012.

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If Keynesian Stabilization Policy as practiced has not been positively harmful, it certainly

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has not been especially effective.

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The insignificant coefficient on GDP growth may be due to multicollinearity.

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When we take out GDP growth and just reverse the left and right-hand sides of this regression,

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so now we have the deficit explaining the unemployment rate, and again we find a significant

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and positive coefficient, meaning that deficits accompany, if not actually cause, higher unemployment.

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We also find that every 1% of GDP the deficit rises based on the size of this coefficient.

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That increases the unemployment rate by one half of one percent, and that's about 700,000

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workers thrown out of work each year for the U.S. today.

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The intercept in this equation can be taken as an estimate of the natural rate of unemployment

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4.66 percent.

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Not that that has anything to do with Keynesian stabilization policy, it's just an interesting

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side effect of this research.

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Regressing current and two-year lagged deficits on the GDP growth rate, we find that deficits

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lower GDP growth, but that it takes up to two years for this effect to manifest itself.

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The very low R-square of about 11% indicates that numerous other factors influence or determine

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and GDP Growth Apart from the Deficit.

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Explaining the standard deviation of unemployment

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with the standard deviation of the deficit

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shows that greater volatility in one

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increases volatility in the other.

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And this is the idea that if you increase the deficit,

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it should cause this standard deviation to go down

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if it's really stabilizing.

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Now, higher instability for the unemployment rate

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actually could be a good thing if in fact larger deficits lowered unemployment, it would

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be good to see it going down by a larger amount. Unfortunately, we've already found that larger

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deficits bring about higher unemployment. So higher volatility in unemployment is certainly

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not a good side effect in this context. Since the increased volatility is in the wrong direction,

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and it turns out to be a very bad thing.

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Finally, regressing the current deficit on the change in unemployment over four years,

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we find that deficits have a protracted positive impact on unemployment four years later.

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I freely admit that I was not a great fan of Keynesian stabilization policy to begin with,

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Stimulus government spending or monetary expansion may have short-run benefits, as Austrian business cycle theory predicts, but it seems clear that their persistent long-term effects are all detrimental. Attempts to stabilize expenditure appear to be inherently destabilizing, resulting in greater unemployment, permanently lost income and output, and lower long-term GDP growth.

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and Growth. Thank you.