'Yes, Virginia, There Really Is a Free Lunch'

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It is time to consider the recommendation and economic analysis of Yale University economist Robert Shiller. He is widely respected, the co-designer of the Case-Shiller index, which traces housing prices in 20 American cities. He coined the phrase “irrational exuberance,” which was made famous by Alan Greenspan in the mid-1990s.

Shiller is a run-of-the-mill Keynesian. His opinions are highly regarded within the mainstream. This is why he gained access to the Op-Ed page of the New York Times on December 25. He presented a Christmas present to the readers: a free gift from the liberals’ replacement of a fat man with a long white beard.

It was the perfect day to receive such a gift in digital Christmas stockings. Readers of the New York Times are educated people, and therefore much too sophisticated to believe in free gifts from a jolly man from the North Pole. They have long since substituted another fairy tale for the story of Santa: free gifts from the jolly people who are elected to Congress.

Men’s faith in free gifts from on high is found in all cultures. For the Israelites in Moses’ day – or at least in the day of the late-eighth-century B.C. scribes who are believed by New York Times readers to have written fables in Moses’ name – there was manna from heaven. Jesus later turned water into wine, though not stones into bread.

Modern Keynesians and their disciples believe that the Federal government can perform similar miracles. They believe that there is no irrevocable scarcity of goods and services, but only a scarcity of public-spirited politicians. They believe that there can be wealth, if not for all, then at least for most of those who reside inside the borders of the United States. They delight in the Keynesians’ version of “Yes, Virginia, there really is a Santa Claus.”

This is why Professor Shiller – a man with a most revealing last name – had his “Yes, Virginia” letter published on Christmas in what used to be known as America’s newspaper of record. It is today merely the newspaper of mainstream liberal opinion.


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Before I present my analysis of Prof. Shiller’s analysis, I owe the reader an explanation. I begin with a premise: Keynesian economists cannot think straight. It takes years of convoluted anti-logic, beginning with the freshmen economics course, to train intelligent people to accept the anti-logic of what is known as the neo-Keynesian/neo-classical synthesis.

In all of modern thought, nothing better illustrates the Hans Christian Anderson tale of the emperor with no clothes. A group of charlatans come to a vain emperor and tell him that they can outfit him with the finest clothes in the world. He accepts their claim. They pretend to spin a wardrobe for him. There is no wardrobe.

We love the story because it illustrates something we all know: those who are rich and powerful are sitting ducks for hucksters and hypesters. Their intellectual vulnerability is in direct proportion to their vanity. They are easily manipulated.

In the story, the adults who see the emperor walk down the street go along with the emperor’s illusion. No one howls in laughter. No one shows derision. Then a child, with nothing to lose socially and no incentive to feign acceptance, shouts out the truth. The crowd breaks into laughter.

The story is of course preposterous. Not because it suggests that an emperor could be sucked in this completely, but because it suggests that the crowd would ever show derision for the emperor. The kid would be taken by his parent and beaten severely for not showing proper respect.

The crowd, if initially silent, would have remained silent. No one would admit to himself or the person next to him that he had been fooled. Such an admission would be an admission of stupidity. It would mean that they were all no wiser than the silly emperor. Worse, it would be an admission that they had temporarily suppressed their common sense for reasons of social acceptance. What kind of person would play the fool? Answer: most of them. What kind of a person would admit in full public view that he had played the fool? Only a child with more sense than experience. He would therefore pay dearly for his frankness.


Prof. Shiller assured his readers that, when it comes to government-funded economic stimuli, once is not enough. There is more where that came from – lots more. THE $858 billion tax package signed into law this month provides some stimulus for our ailing economy. With the unemployment rate at 9.8 percent, more will certainly be needed, yet further deficit spending may not be a politically viable option.

Keynesians see Congress as the equivalent of a dope pusher. “The first one’s free kid. Try it. You’ll like it.” The official Keynesianism of John Maynard Keynes proclaimed that there would be Federal deficits in recession years and surpluses in boom years. There would be far more boom years than recession years. Thus, the Federal debt would not grow. It would shrink.

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That nave view of politicians is long since dead. There are no surpluses. There are only deficits. No matter how large the deficit is, Keynesian economists call for more stimuli.

Original Keynesianism and conventional neo-Keynesianism have always argued that the stimulus must be financed by increased government borrowing accompanied with deficit budgets. The old slogan is “deficits don’t matter.” But this is becoming a hard sell these days. There are voters who say that deficits do matter. These deficits are too large. They must be rolled back generally, although these voters do not say what programs must be rolled back, and by how much, and for how long.

Professor Shiller sees the change in public opinion. He wrote his essay to deal with it. “Instead, we are likely to see a big fight over raising the national debt ceiling, and a push to reverse the stimulus we already have.” He announced the gospel – the good news – of new, improved neo-Keynesianism. In that context, here’s some good news extracted from economic theory: We don’t need to go deeper into debt to stimulate the economy more.

Here we have the promise of a wardrobe specialist who has decided to take up the task of public relations. He is not going to the emperor, who fell for this sales pitch back in 1931, years before Keynes showed up as head pitchman. He is going to those who will be the opinion-makers in the crowd. For economists, of course, this isn’t really news. It has long been known that Keynesian economic stimulus does not require deficit spending. Under certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase.

Notice the phrase in the passive voice: “It has long been known.” By whom has this been known? What Keynesian economists have gone into print previously to explain such a remarkable set of economic conditions?

Ever since 1936, Keynesianism has been known for its gospel of stones into bread: deficits that revive the economy and thereby create positive cash flow that negates the need for another round of deficits. But the deficits never go away, including the Clinton-era deficits, which were funded by Social Security taxes and exchanged for by IOUs written against the Treasury.

Now, we are being introduced to a supposedly old truth of Keynes, namely, that the government can fund the stimulus without resorting to lenders. Best of all, this reasoning is simple. It is simple, because Shiller says so.

The reasoning is very simple: On average, people’s pretax incomes rise because of the business directly generated by the new government expenditures. If the income increase is equal to the tax increase, people have the same disposable income before and after. So there is no reason for people, taken as a group, to change their economic behavior. But the national income has increased by the amount of government expenditure, and job opportunities have increased in proportion.

He began with a false premise, namely, that “On average, people’s pretax incomes rise because of the business directly generated by the new government expenditures.” Which people’s pre-tax incomes? Those who are at the front of the line where the spending will begin. But that does not constitute “on average.”

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Then we are told: “If the income increase is equal to the tax increase, people have the same disposable income before and after.” That is a mighty big if. It is an if that stands a good deal higher than the Empire State Building.

Here is where the spinning of invisible cloth begins. People’s pre-tax income rises, even though they have the same disposable income before and after.

Children begin to giggle. “Stop that giggling!” Prof. Shiller says. “Stop it right now!" Stop it, or you will not be invited to the grand parade. He wrote: “There is no reason for people, taken as a group, to change their economic behavior. But the national income has increased by the amount of government expenditure, and job opportunities have increased in proportion.”

He invoked the sainted memory of the original spinner of invisible clothing. During the Great Depression, there was a debate about “pump priming” – about whether the government had to go into debt to stimulate the economy. John Maynard Keynes, who originated the Keynesian theory in 1936, liked to emphasize that the deficit-spending multiplier was greater than 1, because the income generated by deficit spending also induces second and third rounds of expenditure. If the government buys more goods and services and there is no tax increase, people will spend much of the income that they earned from these sales, which in turn will generate more income for others, who will spend much of it too, and so on.

There it is again: “If the government buys more goods and services and there is no tax increase.” This man and his predecessors have dealt in ifs. They are masters of ifs. But how, you might well ask, can the government increase spending without tax increases? Keynes said: “Borrow.” So have his disciples.

That answer of course raises the question of where the money will come from to increase the purchase of government debt. It raises the question of the economic effects – negative – of such a re-allocation of lenders’ spending. In short, it gets children giggling. For over seven decades, Keynesian advance men of the political spinners of invisible cloth have been working the crowds to head off such giggling. In contrast, the balanced-budget multiplier theory says that there are no extra rounds of expenditure. You get just one round of spending – meaning that the multiplier is 1.0 – but sometimes that is enough.

Stones turn into bread. But they need not be borrowed stones. They need only be taxed stones. Paul Samuelson, an economist at M.I.T., first drew national attention to the balanced-budget multiplier in 1943, seven years after Keynes introduced his theory. The multiplier was an immediate consequence of the Keynes theory, but Keynes didn’t articulate it himself.

I’ll say Keynes did not articulate it! He did not want to be laughed into derision for promoting this version of stones into bread. He knew he had a large enough problem persuading the crowd that borrowed stones would do the trick.

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In 1943, the Federal wage-withholding law went into effect. The level of tax collection doubled. The entire country was under mass inflation, price controls, and bread into stones: anyway, weapons. Ploughshares were being made into swords. So, Samuelson came forth with a new version of stones into bread: hike taxes, not just deficits. Nobody in Washington listened. The deficit grew at astronomical rates. By 1944, a lenders’ revolt threatened to make mandatory hyperinflation.

Samuelson’s suggestion never got traction in Washington. Deficits continued. Then, under Kennedy, top income tax brackets were cut. It happened again under Reagan. Deficits rose. But back in 1944, economists thought differently. Economists embraced this multiplier because it seemed to offer a solution to a looming problem: a possible repeat of the Great Depression after wartime stimulus was withdrawn, and when new rounds of deficit spending might be impossible because of the federal government’s huge, war-induced debt.

It turns out that this worry was unfounded. The Depression did not return after the war. But in the early 1940s, economists justifiably saw the possibility as their biggest concern. Their discussions have been mostly forgotten because they didn’t have much relevance for public policy until now, that is, when we again have a huge federal debt and a vulnerable economy.

So, Keynesian economists got it wrong. When men returned from the war in 1945, and price controls were finally abandoned by Truman in 1946, the economy started to grow. The wartime deficits shrank. The money supply slowed. Price freedom and new optimism led to a great boom.

The problem Shiller faces is that there has never been a theoretical case, meaning a logical case, for the multiplier. The government spends money extracted from the private sector. If there is multiplication at the government’s end of the spectrum, then there is division at the private sector’s end.

That has always been the dirty little secret of Keynesianism. Stones do not turn into bread merely by watering them with the hose of taxes or debt. Why not? Because most citizens get hosed.

Then Shiller gave away the case: Of course, the balanced-budget theorem is only as good as its assumptions. Other possible repercussions could make its multiplier something other than 1.0. The number could be less, for example, if people cut consumption because of psychological reactions to higher taxes. Alternatively, it could be greater if income-earning people who are taxed more cut their consumption less than newly employed people increase their spending. We can’t be sure what will happen.

Citizens will indeed cut consumption, not because of a psychological reaction to higher taxes, but because of a pocketbook reaction. The people taxed have less to invest. They do not invest in the private sector. The jobs created by taxation are jobs in government and jobs dependent on government.

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He knows this. “Researchers haven’t pinned down the deficit-spending multiplier either, even though that has been the focus of their efforts.” I’ll say they haven’t! We have been waiting since 1936 to find out how stones get turned into bread – why money borrowed from one group leads to greater national wealth. “The trouble comes in estimating how people will react in generating those subsequent rounds of spending.” This has always been the problem with Keynesianism. But the balanced-budget multiplier is simpler to judge: If the government spends the money directly on goods and services, that activity goes directly into national income. And with a balanced budget, there is no clear reason to expect further repercussions. People have jobs again: end of story.

Or, put in different terms, emperors do not march down the highway naked as jaybirds. End of story. What kind of jobs? Building highways and improving our schools are just two examples – as cited in 1944 by Henry Wallich, an enthusiast of balanced-budget stimulus who would later become a Yale economist and a Federal Reserve Board governor.

By golly, it’s 1944 again. It’s time to get out those shovels. Get those high-tech workers back on the job with shovels. Get those $20-an-hour union members out into the highways and byways. That will do it.


Prof. Shiller insisted that there is no theoretical problem of stones into bread. There is only a political problem. At present, however, political problems could make it hard to use the balanced-budget multiplier to reduce unemployment. People are bound to notice that the benefits of the plan go disproportionately to the minority who are unemployed, while most of the costs are borne by the majority who are working. There is also exaggerated sensitivity to “earmarks,” government expenditures that benefit one group more than another.

So, it’s a political issue of who gets the newly baked stone bread. There is no problem with the recipe. There is only a problem with distribution of the bread. Those pesky Republicans will not let Congress cook up its never-ending supply of stone bread.

“No, Virginia, there is no Santa Claus under the tight-fisted rule of Republican hard-liners, who drag their feet at increased taxation, forcing the soup kitchen to rely on borrowed stones.” Another problem is that pursuing balanced-budget stimulus requires raising taxes. And, as we all know, today’s voters are extremely sensitive to the very words “tax increase.”

But, in the world of the New York Times, Christmas will surely reappear. Virginia will get another visit from the ultimate Santa: Congress. But voters are likely to accept higher taxes eventually, as they have done repeatedly in the past. It would be a mistake to consider the present atmosphere as unchangeable. It’s conceivable that an effective case will be made in the future for a new stimulus package, if more people come to understand that a few years of higher taxes and government expenditures could fix our weak economy and provide benefits like better highways and schools without increasing the national debt.


I have quoted at length from Prof. Shiller’s article. Had I summarized it, too many readers would conclude, “No one in his right mind would say anything so preposterous.” They would be correct. That is the problem. Keynesians are not in their right minds. It is necessary to quote them verbatim to prove the extent to which they are not in their right minds.

Call me an advance agent of the gigglers. There are more gigglers out there today than in 1936 . . . or 2006.

Someday, some child is going to shout: “The emperor has no clothes!” And, lo and behold, the crowd will start giggling.

Then they will replace the emperor and go looking for the wardrobe spinners and their advance agents. They will not go looking for them to grant them tenure.

Until then, those of us who are prone to giggling will enjoy the show.

There will come a day when the New York Times will fold up financially because it cannot sell day-old printed news, silly Op-Ed essays, and the daily crossword puzzle. That will be a day for celebrating. We can call it the ideological multiplier effect. More people will be cheering than crying.

December 29, 2010