Obama's Stimulus Package Is Working: Keynesian Economics is Alive

How the Treasury and the Fed handled the crisis, and the rapidity with which Congress moved to stimulate the economy, shows that fiscal and monetary policies do work; that Keynesian economics is still relevant to our post-modern times.

In October 1929 the stock market crashed, making obvious the problems that caused the Great Depression. This market crash of 1929 may be the worst economic crisis in American history.

In September 2008 The worst liquidity crisis unfolded over a weekend: Lehman Brothers heads for bankruptcy, AIG begs for survival, Bank of America swallows Merrill Lynch, and all hell breaks loose.

But will the financial crisis send the economy on a spiral downward? Will a Great Depression follow?

Economic history shows that two of the main causes of the Great Depression were:

  • Lack of liquidity (liquidity trap)
  • Lack of regulation of the banks (Erasure of the Glass-Steagall Act)

The University of Chicago economist, Milton Friedman blamed the Federal Reserve for shrinking the money supply when it should have been expanding it. The velocity of money is what expands GDP, Friedman argued; conversely the lack of it causes deflation and contraction. This argument made sense then, and for many economists it has become an economic lesson from which we can all benefit.

While many -especially Republicans- accept this explanation, many conservatives still feel that government intervention only makes things worse. So if government intervention (lack of liquidity) was a main cause of the Great Depression, why not learn from the past and do something about it? Markets will not cure themselves-for sure.

Yet, the Fed's injection of 80 billion dollars (TARP money) into the ailing financial system, conservatives argue, was a step toward socialism. It wasn't the most dignified picture to see Hank Paulson and Ben Bernanke go hand in hat to Congress, but a little humility can take us a long way-the financial crisis of 2008 was managed.

With the financial market stabilized to some extent, the Dow back to over 10,000 points, and a 3.5% growth in GDP, the nay-sayers and anti-government critics are finding impossible to refute the fact that the injection of 80 billion dollars by the Fed has worked.

But let's not forget that the follow up stimulus package (Obama's stimulus package) also had a benign role in the stabilization of the markets.

With the advantage of perspective, professional economists should look at the data for the money supply -M2, Velocity, and the multiplier effects- and determine empirically how exactly the infusion and the stimulus package impacted GDP so at to grow to 3.5%.

Have we avoided a recession? The answer is yes. Technically. Those who advocate a government hands-off policy would be looking -at this very moment- at the beginning of another Great Depression. There's a role for government and we learned this from history.

How the Treasury and the Fed handled the crisis, and the rapidity with which Congress moved to stimulate the economy, shows that fiscal and monetary policies do work; that Keynesian economics is still relevant to our post-modern times.

Economics is a "dismal science," but it becomes science when empirical facts support opinions. That we have recovered is an empirical fact.

Now what remains to be done is a reinstatement of Glass-Steagall-or something comparable. By now it is evident that knocking down the wall that separated investment banks from commercial banks wasn't such a good idea. There's much blame to be apportioned for this mishap, but critics should not be mired in this. Let Congress rebuild the wall again.

Retired. Former investment banker, Columbia University-educated, Vietnam Vet (67-68). For the writing techniques I use, see Mary Duffy's e-book: Sentence Openers. To read my book reviews of the Classics visit my blog: Writing To Live.

Copyright © 2009 Marciano Guerrero