New Keynesians; M. Skousen

-Paul A. Samuelsonl "Higher saving leads to faster growth ... " -N. Gregory Mankiw2 T he two quotations above dramatically demonstrate the stark contrast between the "old" Keynesians and the "new." Sam uelson and the old-style Keynesians start with the "general" theory of unemploy ment equilibrium and end with the classical model of full employment as a "special" case. As long as there are unemployed resources-which, according to the old Keynesians, is most of the time-thrifti ness is bad and expansionary monetary and fiscal policy (i.e., inflationand deficit spend ing) are good. For 50 years, this "demand management" model has been the standard approach in college economics. The New Keynesian Revolution Now along comes a new generation of economists, known as "new" Keynesians, who have wisely changed their way of thinking. In the most popular textbook Dr. Skousen is an economist at Rollins College, Department ofEconomics, Winter Park, Florida 32789, and editor of Forecasts & Strategies, one of the largest investment newsletters in the country. For more information about his news letter and book, Economics on Trial, contact Phillips Publishing Inc. at (800) 777-5005.

on macroeconomics, author N. Gregory Mankiw reverses the standard Keynesian pedagogy. Mankiw, you may recall, is the young Harvard economist who was paid a $1.4 million advance last year to write the next "Samuelson" textbook. (See my col umn, The Freeman, October 1995.) His mammoth advance was due, in part, to the success of his previous textbook on macroeconomics, last published in 1994. Macroeconomics may be a harbinger of what's to come. In a brilliant move, he begins with the classical model and ends with the Keynesian model, just the opposite of Samuelson & Company. Mankiw states in the preface, "in the aftermath of the Keynesian revolution, too many economists forgot that classical economics provides the right answers to many fundamental ques tions. " Under Mankiw's long-run "general equi librium" model, what are the effects of an increase in government spending? Crowd ing out of private capital. "The increase in government purchases must be met by an equal decrease in investment. . . . Govern ment borrowing reduces national saving"

(p. 62). Economic growth is discussed up front, not at the end, as most textbooks do. Using the Solow growth model, Mankiw takes a strong pro-saving approach. He maintains that "the saving rate is a key determinant of the steady-state capital stock. If the saving rate is high, the economy will have a large capital stock and a high level of out639 640 THE FREEMAN • SEPTEMBER 1996 put. If the saving rate is low, the economy will have a small capital stock and a low level of output" (p. 86). What is the effect of higher savings? It's positive. "An increase in the rate of saving raises growth until the economy reaches the new steady state," although the law of diminishing returns suggests that' 'it will not maintain a high rate of growth forever" (p. 86). Mankiw writes favorably toward those nations with high rates of saving and capital investment, and even includes a case study on the miracles of Japanese and German growth (examples virtually ignored in Samuelson's textbook).

He supports efforts to increase the rate of saving and capital formation in the United States, including the possibility of alter ing Social Security from a pay-as-you-go system to a fully funded plan, though he does not discuss outright privatization (pp. 103-4). The cause of unemployment? Relying on the "natural" rate of unemployment hy pothesis, Mankiw suggests that unemploy ment insurance and similar labor legislation reduce incentives for the unemployed to find jobs (pp. 121-5). He provides evi dence that unionizing labor and adopting minimumwage laws increases the unem ployment rate (pp. 127-30). He offers a case study on Henry Ford's famous $5 workday as an example of wages determined by productivity. He approvingly quotes Milton Friedman on monetary theory: "Inflation is always and everywhere a monetary phenomenon. " Mankiw uses numerous examples, includ ing hyperinflation in Interwar· Germany, to confirm the social costs of inflation (pp.

161-9). Sins of Omission Not all is right with Mankiw, however. In Mankiw's model, tax cuts have the same effect as deficit spending-by raising con sumption, it "crowds out investment and raises the interest rate," he says (p. 64). However, he fails to realize that tax cuts also stimulate savings, as the graph (below) FIGURE 13-5 Inverse Relationship between Taxes and Savings 1980197519701965 OL.--- L-L- L-__--J'--- __--J --J 1960 Q) 15 E00 .£; (ij c 0C/) 10Q>a. 0 C Q) ~ Q) 5Q. 20 Source: Edwin G. Dolan and David E. Lindsey, Economics (The Dryden Press, 1988, Perspective 11.1) NEW KEYNESIANS FINALLY REJECT KEYNES'S "GENERAL" THEORY 641 from Dolan and Lindsey clearly demon strates. Not all tax cuts will be spent on consumer goods. Further more, Mankiw apparently as sumes that government spending remains the same when tax cuts are put into effect, thus raising the deficit. He repeats the com mon historical error that the Reagan tax cuts enlarged the deficit, and thereby raised interest rates and lowered national savings.

(p. 65) In fact, while marginal tax rates declined, tax revenues rose during every year of the Reagan presidency. Tax cuts didn't cause expanding deficits, excessive federal spending did. The second half of Mankiw's textbook introduces all the standard tools of Keynes ian modeling-aggregate supply (AS) and aggregate demand (AD), the multiplier and accelerator, and IS-LM model. The author presents real business cycle theory, wage rigidity, money neutrality and the Ricardian THE VlvREPORTED NEWS™ Equivalence Theorem, all in a bewildering effort to explain economic fluctuations "in the short run." Although he includes a section on Robert Lucas, Jr., and the Ra tional Expectations School, he has virtually nothing to say about the supply-siders and the Austrians, a major omission. These two schools could have cleared up a lot of confusion about macroeconomic theory and policy. Still, free-market economists should cel ebrate in knowing that the profession is slowly moving in the right direction-to ward fundamentally sound economics.

That's quite a feat for a man (Mankiw) who named his dog "Keynes." D 1. Paul A. Samuelson and William D. Nordhaus, Econom ics, 15th ed. (New York: McGraw Hill, 1995), p. 357. Similar anti-saving statements have existed in all previous editions of Samuelson's Economics. 2. N. Gregory Mankiw, Macroeconomics, 2nd ed. (Worth Publishers, 1994), p. 86. :::syRdicaficfcolumnist Joe Sobran 642 BOOKS Restoring Hope in America: The Social Security Solution by Sam Beard Institute for Contemporary Studies. 1996. 220 pages. $14.95 paperback Let's Get Rid of Social Security: How Americans Can Take Charge of Their Own Future by E. J. Myers Prometheus Books. 1996. 273 pages. $25.95 Reviewed by John Attarian M ost Americans now realize that when the huge Baby Boom generation re tires, supported by a slower-growing Baby Bust taxpaying workforce, Social Security will go broke. Proposals are emerging to avert disaster, with most, like those here reviewed, entailing some privatization.