Trump’s ‘pump’ looks like liberal economics

When Donald Trump described his tax and spending proposals as “priming the pump,” we came full circle on the GOP’s approach to fiscal policy. Forth-six years after Richard Nixon offended many in his party by acknowledging, “I am now a Keynesian” a Republican president stated he was following the ideas of the long-dead British economist long associated with liberal economic policies.

True, the president did not speak the name “John Maynard Keynes.” But the term “pump priming” is as specific to Keynesian thought as “surplus value” is to Marxism. The idea is that government deficit spending combined with a looser money supply can get a stalled economy moving again. It is a short-term act that takes no account of longer-term incentives for savings and investment. It also assumes a degree of naiveté on the part of consumers and taxpayers. In other words, it represents everything the GOP ostensibly has opposed for 40 years and that was, at least temporarily, swept away by the “rational expectations revolution” within economics as an academic discipline.

Ironically, Trump affirmed his Keynesian views a few days before the announcement that new claims for unemployment hit the lowest weekly level since 1988, when there were 70 million fewer Americans than today. By most key economic indicators, the economy is expanding well, exactly the opposite of when fiscal stimulus would be called for.

The history of all this is instructive, with Minnesota-based economists playing roles a key points.

From the early 1800s, economists favored limited government intervention in the economy. The overall economy might fluctuate, but it was best that government stay out. Economic forces in free markets themselves would return things to equilibrium. That outcome might not be ideal for everyone, but it would be better than anything brought about by government action.

This was the prevailing wisdom in the discipline and was accepted by conservative political parties in most Western countries. But the economic implosion of the Great Depression shook this certainty.

Governments began tentative make-work spending programs driven by pragmatism rather than economic theory. But in 1936, Keynes, already Britain’s most famous economist, published his General Theory of Employment, Interest and Money. In it, he argued that the self-correcting free market functioned in some situations, but not in all. There was room for government to improve on the market when economies fell into recession.

The prescription was to cut taxes and increase spending when faced by recession, together with a central bank increasing the money supply and thus lowering interest rates. When the economy boomed, the opposite should occur — tax increases, spending cuts, tighter money and higher interest rates.

The Franklin Roosevelt administration never officially adopted these ideas and actually threw the economy back into recession in 1938 with an ill-timed effort to balance the budget. And all the rules were thrown to the wind once World War II broke out and then culminated with United States having an enormously larger economy then it did before the war.

Democrat Harry Truman and Republican Dwight Eisenhower both were budgetary hawks, believing it important to reduce enormous debts contracted during the war. Neither was driven by any particular economic theory, just common sense. The economy grew, but some thought we could do much better.

These included Walter Heller, an articulate economist at the University of Minnesota and an advocate of active Keynesian policies to smooth out growth. Heller became the chief adviser to John F. Kennedy, who won in 1960 on a platform of faster economic growth. Heller was a good economist, but not a theoretical heavyweight. He did bring in a “dream team” of bright young staffers, two of whom eventually would earn Nobels.

Heller was as close to a rock star as any economist has ever come. On the cover of Time and other prominent magazines, interviewed daily, he was the face of the “new economics” of government “stabilization” policy. And what he advised Kennedy to do only mirrored what was being taught in nearly all college econ textbooks.

JFK was not skilled in dealing with Congress. The tax cut for which he is famous was only passed after his death when Lyndon Johnson ramrodded it through. But the economy was expanding, millions of baby-boomers were hitting the labor force, the government was spending billions on space exploration, the cold war and, increasingly, Vietnam. Output burgeoned, employment grew and, despite social and political unrest, the 1960s were the strongest years of economic growth in the last seven decades. Keynesian doctrines reigned supreme.

There were dissenting voices, most notably Milton Friedman and other “monetarists.” And many Republicans retained the faith in free markets and suspicion of “government interference” that they had always held.

So when Richard Nixon announced his reliance in Keynesian ideas in planning the tax and spending proposals for the new fiscal year of July, 1971, many Republicans heard apostasy. But it was the prevailing wisdom of the time.

Inept management of the money supply by Arthur Burns, Nixon’s own appointee to head the Federal Reserve, and a “monetary hawk,” discredited Keynesian policies. Alternate efforts in the 1970s to step on economic gas and brake pedals to speed or slow the economy to correct unemployment and inflation problems seemed to lead to higher levels of both, an outcome termed “stagflation.”

Within economics, a younger cohort of faculty at the University of Minnesota, many of whom also has positions with the Minneapolis Federal Reserve, together with other scholars at Chicago and Carnegie Mellon, looked at what would happen under the most accepted ideas of how individual humans make decisions. They concluded Keynes’ ideas held fatal flaws. Their “rational expectations” critique rapidly gained acceptance within the discipline.

At a fringe of economics, a few people took a different crack at Keynesian doctrine. They argued that it focused on increasing or decreasing overall demand for goods but ignored factors that influenced production or supply, such as the disincentives to saving and investment posed by high marginal tax rates or by complex regulation. These “supply-side” economists never were a large group within economics, but one, Arthur Laffer, caught the attention of politicians, including key people in the incoming Reagan administration, with the seductive argument that tax cuts would pay for themselves — an argument we still hear today.

Up to that point, few economists of either political party would have disagreed with the general ideas of the supply siders. High marginal tax rates can be a disincentive to saving. Ill-designed or unneeded regulation can reduce economic efficiency. The argument would have been about the degree of action to take and when. But no reputable economist buys the argument that cutting income tax rates will so spur output that tax revenues will actually rise.

This is not a left-right issue. Some of the harshest critics of this fallacy are on the conservative side of the disciplinary spectrum and among those most harshly critical of Keynesian ideas.

Ironically, an idea that was broadly rejected by economists became the core of the contemporary GOP economic program. Keynesianism was bad, supply-side economics was good and that meant self-paying tax cuts. Yes, Nixon admitted following Keynes’ ideas but no Republican since 1980 has openly done so. Nor has Trump in so many words, but to use the “pump-priming” metaphor says the same thing.

The Democrats have been consistent. For decades, they have liked the idea of government being able to actively manage the national economy. Whether they cite his name or not and whether they understand the degree to which ongoing economic research undermined his theories, Democrats are Keynesians in economic policy.

Republicans are caught in a surrealistic warp. GOP senators like Alabama’s Richard Shelby regularly excoriated Barack Obama’s nominees to the Fed board for being Keynesian. But many also call for enactment of a law requiring the Fed to follow some form of the “Taylor Rule” in setting monetary policy. John Taylor is a Republican, but his rule — raise interest rates when gross domestic product grows fast and unemployment is low, cut them when GDP slows and unemployment rises — is about as Keynesian as one can get.

And now we have a president, his secretary of the Treasury, and his key economic adviser, all touting a big tax cut because it will boost overall demand — spending by households and businesses. That is Keynes, circa 1936.

A University of Minnesota economist helped usher in the heyday of Keynesian policymaking and later U professors led in refuting Keynes’s thought 20 years later. Now, a new microeconomics, based on more realistic and provable ideas of human action, is hot in the contemporary discipline. The University of Minnesota is out of the spotlight. Ironically, the Minneapolis Fed, the research department of which played a key role in the anti-Keynesian 1980s, has had two presidents in a row who, in practice, are moderate Keynesians. And where the Trump administration will actually go, no one knows.