More (Mis)forecasting Folly from the Keynesians

Clinton-era chair of the White House’s Council of Economic Advisors Laura Tyson advocates for a second stimulus in a New York Times oped (8/30/2010), writing:

“Our national debate about fiscal policy has become skewed, with far too much focus on the deficit and far too little on unemployment. There is too much worry about the size of government, and too little appreciation for how stimulus spending has helped stabilize the economy and how more of the right kind of government spending could boost job creation and economic growth. By focusing on the wrong things, we are in serious danger of failing to do the right things to help the economy recover from its worst labor market crisis since the Great Depression.

“The primary cause of the labor market crisis is a collapse in private demand — the same problem that bedeviled the economy in the 1930s. In the wake of the financial shocks at the end of 2008, spending by American households and businesses plummeted, and companies responded by curbing production and shedding workers. By late 2009, in response to unprecedented fiscal and monetary stimulus, household and business spending began to recover.”

The danger, she argues, is not following up the first stimulus with a second one. I respond directly in a post on National Review‘s blog The Corner, arguing that this one-sided view of the recession–that the only problem is a failure of demand/spending–ignores fundamental readjustments that have to be made on the supply side of the economy (more specifically investment), noting:

“Moreover, stimulus advocates like Tyson and Krugman still believe that spending, any spending, even if it’s poorly targeted and wasted on worthless projects, creates jobs and economic growth. They are wrong. These projects further distort investment and spending in the economy and set us up for prolonged economic stagnation, if not a double-dip recession. Investments have to be productive to have long-term economic viability and create wealth.

“Tyson’s op-ed shows that many of the Keynesians among mainstream economics professionals still haven’t learned the lessons of this recession. They continue to put faith above reason in their macroeconomic models even in though their models have been patently inept at diagnosing, let alone predicting the turns in the economy.”

For more on my critique of macroeconomic forecasting and the stimulus, its limits and the implications for economic growth, see also my Out of Control blog post (August 5, 2010) on the Blinder and Zandi report on stimulus job creation and my articles in National Review “Naive Statistics” (November 2, 2009) and “Wrong Road” (December 15, 2008).