Does Keynesian Economics Work?

Federal Reserve Chairman Ben Bernanke gave his semi-annual testimony to Congress on monetary policy Wednesday. While cautioning lawmakers that job numbers are still a concern, Bernanke indicated that because of measures taken by the government and the Fed, we are in the process of economic recovery. But can Americans trust Bernanke’s testimony?

Economic and monetary policy “luminaries” like Ben Bernanke, Alan Greenspan, Hank Paulson, and Tim Geithner- along with the rest of America- were blindsided by the financial meltdown, credit crunch, housing bust, and subsequent recession. These are all “really, really smart” guys who “know what they’re talking about” and understand all of the complicated intricacies of economics, which are all but ineffable to the layman. But they got it wrong just like everyone else.

Can we trust someone to predict our recovery from this economic crisis, who didn’t even see the crisis coming? Instead, we should listen to the (very) few analysts who predicted the economic collapse with frightening accuracy. What they all had in common was their adherence to a school of economic thought called Austrian economics, because it originated with several Austrian economists like Ludwig von Mises and F. A. Hayek.

What the Austrian economists said was actually very simple: that you have to produce something before you can consume it. Who could disagree with such an obvious statement? In other words, it is production that drives economic growth. And in order to produce, you have to save. An economy has to produce more than it consumes, and invest the surplus in more production in order to grow. Growth is driven by investment, and investment must be driven by savings, which comes from a surplus of production.

But most economists today (like all the ones that missed the economic crisis, but presume to accurately forecast our recovery from it), are not Austrians. They are Keynesians- the school of economic thought named after the economist, John Maynard Keynes (pronounced “canes”). They don’t believe that production drives the economy. Oddly enough, they think that consumption does. They believe that a central bank like the Federal Reserve is necessary to drive consumer spending by making it easy to get credit. The Fed does this by keeping interest rates (which is simply how much it costs to borrow money) artificially low.

Remember, that Austrian economists believe that growth is driven by investment, and that investment must be driven by savings. Keynesian economists think that investments should be driven by credit. But when we make credit too cheap by holding interest rates low, we fuel unwise investments and runaway speculation. We also artificially stimulate demand for consumer goods like houses, which artificially drives up their prices, so that people think they are great investments. But those prices can’t go up forever. They are only stimulated by a false demand, which is in turn stimulated by an easy credit policy that will eventually have to come to an end. And that’s exactly what happened to the US economy.

So what do the Austrian economists with all their new-found credibility as accurate economic forecasters have to say about our recovery? They agree with Governor Gary Johnson, that our economy is still on shaky ground and might very well experience hyper-inflation- a crowded market of dollars that pushes up the prices of consumer goods, making everything that people like you and me buy- groceries, gas, electricity, etc. -a LOT more expensive. How can our government fix this?

To begin with, we need more oversight of the Federal Reserve. Transparency will help Americans to understand where their money is going and why our dollar is losing so much of its value. The government should also cut deficits and balance its budget. Instead of endless new spending, programs, pork, and bailouts, it’s time for our government to get smart and practice some fiscal responsibility. As any good Austrian economist would say, we cannot keep spending money that we don’t have. Only a Keynesian could disagree.