The CATO institute is the foremost libertarian political organization.  I like their blog because even though it’s ideological, it’s non-partisan.  Meaning they will criticize both political parties and criticize both depending on what their advocating.  That being said, in a recent post they took some cheap shots to try and disprove Keynesian economic theory.

Wikipedia gives a good summation of Keynesian economic theory:

Keynesian economics (pronounced /ˈkeɪnziən/, also called Keynesianism and Keynesian theory) is a macroeconomic theory based on the ideas of 20th century British economist John Maynard Keynes. Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle

Economists who accept this theory usually advocate that when the economy is doing good – as indicated by rising inflation- the government should reduce spending and pay off past deficits, but when the economy is bad – as indicated by high unemployment – our government should increase spending in spite of any deficits that may occur.  The key part of the theory is that in a typical business cycle unemployment and inflation are indirectly related.  As one rises, the other should fall.

It is with this part of the theory that CATO tries to “disprove” in a post called Does High Unemployment Make Inflation Impossible?

If this “slack theory” of inflation makes you too sanguine about future inflation, recall that it is the same theory that predicted stagflation would be impossible in 1973–75 and 1979–81. Figures from The Economist, August 21, raise some doubts.  The latest unemployment rate in Argentina is 8.3%, but CPI inflation over the past year was 12.2%. Unemployment in Venezuela is 8.2%, but inflation is 13.3%. Unemployment in Egypt is 9.1%, but inflation is 10.7%.  Unemployment in India is 10.7%, but inflation is 13.7%.  Unemployment in Turkey is 11%, but inflation is 7.6%.   Wasn’t high unemployment supposed to make high inflation impossible

My first problem with this is that Keynes never said High Unemployment makes inflation impossible, so I think CATO setup a straw man argument.

My second problem is the 2 examples used to point out when the united states had both high inflation and high unemployment.    Both of them were caused by a giant oil shock(1973 and 1979).  No macroeconomic theory can fix or prevent a sudden scarcity of a natural resource that is integral to an economy.  Of course it’s going to wreck it.  Those 2 cases weren’t caused by a typical business cycle and had a clear cause.

Third, and finally, CATO tries to disprove their straw man argument by listing off countries that have fairly high unemployment and inflation.  The problem with this is that typical inflation and unemployment is different for every country.  It varies based on natural wealth of the country, their various policies and laws, and levels of corruption.  Therefore comparing one country to another isn’t useful.  You have to compare trends within the country.

Let’s take a look at Egypt.  According to the CIA, unemployment in Egypt was 9.4%, but inflation was 11.8% in 2009, but in 2008 unemployment was 8.7% and inflation was 18.3%.  So when CATO says that inflation in Egypt is 10.7% you can see that 10.7% is a low inflation rate… for EgyptTurkey‘s numbers play out similarly to Egypt’s.   Inflation was 10.4% in 2008, and went down to 6.3% in 2009.  At the same time, unemployment, as Keynesian economists predict, went up from 11.2% to 14.1%.  I went through all of the countries listed, and India was the only country whose inflationunemployment didn’t act in perfect accordance of Keynesian economics.  However, in India’s case, it’s GDP grew at the same rate both years suggesting that something else was going on because GDP growth and employment rate almost always rise and fall together.

In the end, India and the two oil shocks of the 1970s does disprove the straw man argument that CATO setup.  It is possible to have high unemployment and high inflation, however I think that’s a long ways from disproving what Keynes actually theorized.

4 comments on “CATO’s Cheap Shot at Keynes

  1. I don’t like Cato except for a few positions against the IMF. However, I do think that government spending should be increased in tech and lowered most other places. I think we run the risk of bond vigilantes. Right now we face deflation. And so some targeted spending is important.

    But I think we wasted trillions on banksters, and the Fed was part of it. They caused the bubble and allowed Wall Street free reign. Greenspan in Feb. 2004 said we all should buy adjustable mortgages, so we know that the Fed was a part of the ponzi scam. So we can’t trust them. They should keep their nose clean for decades!

  2. I understand why alot of people Keynesian economics. It makes ya feel safe knowing the Gov. will be there. Problem is that they dont save you only theyre own asses. How did a company get to big to fail esspecially those started by the Gov to fix hard times. (fanny may/freddy mac and so on). Not only that but once you get the gov. invaulved they never wanna leave.
    Its as if your allergic to bandaids, however you get a cut so ya put on. The cut is good but now theres a rash. So ya put a bigger on to cover that and so one till your covered in bandaids and though your covered your also hurting yourself more when ya you had to do was clean out the wound. So it is with Capitalism leave it alone and itll heal itself.

  3. The Federal National Mortgage Association (FNMA) (OTCBB: FNMA), commonly known as Fannie Mae, was set up as a stockholder-owned corporation chartered by Congress in 1968 as a government-sponsored enterprise (GSE), but founded in 1938 during the Great Depression. The corporation’s purpose is to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities,[3] allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on thrifts.[4]

    The federal takeover of Fannie Mae and Freddie Mac refers to the placing into conservatorship of government sponsored enterprises Fannie Mae and Freddie Mac by the U.S. Treasury in September 2008. It was one financial event among many in the ongoing subprime mortgage crisis.

    So you see, the problem isn’t capitalism its crony capitalists and out Briliant leaders in washington that started the whole mess by getting invauvled. Just more and more bandaids on a bigger rash.

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