Beyond the 1937-like craze in Congress today over cutting the budget deficit, there is a more serious debate going on in the US over how to stimulate aggregate economic demand in order to spur more rapid job growth. In this debate, there are competing views over whether to raise spending or cut taxes – sometimes referred to as left Keynesians and right Keynesians. Macroeconomists have mainly favored the spending route because the historical evidence is that spending gives more bang for the deficit buck since the initial impact brings a one-for-one boost to demand, while a tax cut initially loses some bang because tax cut recipients initially save a part of their higher disposable income. But there is agreement among those who engage in this debate that tax cuts too will stimulate demand and job growth, especially when they are aimed at lower income Americans who spend more of their disposable income on the margin than do the rich.

In fact, the greatest moment of success of Keynesian policy in the history of the United States is not the New Deal, as is often claimed by proponents of greater deficit spending in the current crisis. The height of the influence and success of Keynesian policy advisers was the Kennedy administration’s income tax cut of $13.5 billion over three years. The policy was strongly urged by President Kennedy’s Council of Economic Advisers, led by the great American Keynesian economists James Tobin, Walter Heller and Arthur Okun. Facing unemployment rates around 7 percent, the economists sought to bring it down to 4 percent. By early 1964 (after Kennedy’s death), the proposal was passed into law. The tax cut is attributed with moving the economy to 4 percent unemployment and a very high rate of capacity utilization. In his history of that era, Michael Bernstein (A Perilous Progress) writes that “by the fall of 1964 the success of the tax cut was so apparent that, in the words of Arthur Okun, ‘economists were riding about as high a crest of esteem and respect …as had ever been achieved.’ ” It was the bold advice of Democrats Heller, Tobin and Okun that initially established the Council of Economic Advisers as an important political institution.

Kennedy had the luxury of a Congress controlled by the Democrats. Today, President Obama does not have this luxury. Thus, a leader who understands the desperate need for stimulating demand also faces a Congress that will not move an inch in the direction of left Keynesianism. Obama’s jobs proposal recognizes the essential need for demand stimulus, that fallacy of the right-wing argument that a higher deficit in the short-run creates damaging psychological uncertainty, and the political reality that right Keynesianism may be the only route to demand stimulus. While the proposal of $447 billion in deficit stimulus, $253 billion of which takes the form of tax cuts, is too small and comes disappointingly late in the business cycle, it nonetheless represents a very positive step in the current landscape of economic policy. In two senses, then, President Obama has done the right thing.

The failure of economics in the runup to and aftermath of the Great Recession has generated a lively debate about how to reform economics and more specifically about the renewed relevance of Keynesian economics, which had fallen out of favor since the 1970s. The Keynesian message, so important in this latest round of political wrangling over the increase in the US debt ceiling, is that cutting government spending in a slump will only worsen the unemployment problem. The role of expansionary fiscal policy, according to Keynesianism 101, is to provide demand for goods (and thus for employees to produce those goods) when the main sources of demand in a capitalist economy — households and businesses – are not providing a level of demand necessary to generate a socially acceptable level of unemployment.

Keynesianism 102 is about the multiplier effect of changes in spending. This is the notion that an increase in demand (from any source, not just government but certainly including government) will impact employment and incomes with a ripple effect. This includes a direct impact and then a secondary impact when the direct incomes are then spent (in some fraction) and an additional fraction of that is spent, etc.

There are two corollaries to the lesson of Keynesianism 102 that are worth mentioning because they have been raised in the current policy debate. The first is about the differential multiplier effect of a spending increase compared to a tax cut. Empirical studies show that the multiplier effect of the former is greater than the multiplier effect of the latter. The second is about the differential multiplier effect depending on the income of the recipients. Since the poor are more likely to spend a higher percentage of additional disposable income than the rich, a tax cut that benefits low-income people will have a bigger multiplier effect than a tax cut that benefits the rich.

These lessons have not been integrated into current economic policy in the US, where deficit spending and progressive tax reform and expanded benefits for the poor and unemployed have been successfully resisted by the Republican congress. Nonetheless, they are well-established lessons of Keynesianism that most professional economists would accept.

The argument against Keynesianism 101 revolves around the psychology of investor confidence in the face of a rising fiscal deficit. The argument is that business people will reduce their investment spending when they see the government deficit becoming very large because it signals the likelihood of some detrimental future adjustment – either in interest rates, tax rates or government outlays – that will be detrimental for future profits. There is simply no empirical evidence to support this theory compared to Keynesianism 101.

But all this is sideshow in comparison to the lesson of Keynesianism 103.  The fundamental economic point of Keynes’s 1936 General Theory of Employment, Interest and Money was not about fiscal policy or the multiplier or income distribution.  It was about the fact that economic equilibrium (a stable condition from which no economic change would occur without external impetus of some sort) will not necessarily be characterized by full employment. Economists prior to (and some subsequent to) Keynes thought that free market economies would naturally adjust to full employment, as an excess supply of labor would lead to a lowering of wages and a corresponding increase in the amount of employment. Keynes explained that the natural state of a capitalist economy is “unemployment equilibrium,” and without a shock to aggregate demand conditions, there was no reason why the economy would not stay at this unemployment equilibrium. Keynes’s insight implied that the wage reduction strategy was not just theoretically wrong but, if implemented, would likely make the situation worse, since it involved a reduction in household buying power and thus would reduce business confidence.

A prospect as disastrous as the second “dip” that the American economy is about to experience is that of a long period of high unemployment that has no natural tendency to reverse itself. We should not stop our analysis at Keynesianism 101 and 102, since the great social problems facing America are understood best by Keynesianism 103.

So what is to be done? Paul Krugman has been a superb critic of the politicians’ focus on the deficit and the debt rather than on job creation. But he has been relatively quiet about what could be done if in fact the political winds were to shift. Robert Reich has been more explicit. His proposals for job creation include:

1. An additional cut in the payroll tax on employees and employers
2. An increase in infrastructure investment

My guess is that President Obama’s speech this evening will address these issues. If it does, it should be understood as not just a political maneuver, but as a serious attempt to tackle our economic problems.