One Reason Why Keynesian Stimuli Aren’t Working: They Aren’t Keynesian

Nick Gillespie, September 7, 2011

In The Washington Times, businessman Mike Whalen (who’s associated the free-market think tank NCPA) writes up an interesting take on why various federal stimulus program have tanked like the Titanic(while causing few ripples on the way down).

His points are worth thinking about.

According to the Keynesians, the remedy for today’s economic problem is for the federal government, as the single biggest actor, to “prime the pump.” As government money starts to ripple through the economy, consumers and businesses will be encouraged and cautiously respond with limited increases of their own. Vroom! The economic engine steadily revs up in billions of responsive steps until happy days are here again. This pump-priming reaction is termed the “multiplier effect.”

There are many reasons to doubt that the multiplier exists at all and if it does, it certainly isn’t at the levels the Obama administration has claimed. As Reason’s economics columnist Veronique de Rugy has pointed out, the administration claimed that one dollar of government spending would create as much as four dollars in economic activity while other economists were coming in with multipliers of between 0.8 and 1.2, meaning that each dollar of government spending might yield just 80 cents to $1.20 in activity. Even if accurate, that buck-twenty is nothing to write home about, especially given the fact that government spending has to be pulled out of some other part of the economy via current or future taxes or borrowing. Which casts huge doubt on the possibility of any stimulus to work.

But Whalen isn’t simply dumping on Keynesianism, he’s bent on pointing out that even its latter-day adherents are straying far from their master’s theory. And in this, he’s surely correct. As Allen Meltzer has argued, Keynes was against the very sort of large structural deficits that characterize contemporary federal budgets and policy, believing instead that deficits should be “temporary and self-liquidating.” And Keynes believed that any sort of counter-cyclical spending by government should be directed toward increasing private investment, not simply spending current and future tax dollars on public works projects.

Or, to put it another way: If the federal government had a strong track record of responsible spending, it would mean one thing if it went into hock for a short period of time to goose the economy (again, whether this would work is open to question). It means something totally different when a government that spent all of the 21st century piling on debt and new, long-term entitlement programs responds to an economic downturn first by creating yet another gargantuan entitlement (Obamacare) and taking on even more debt in the here-and-now. This cuts in a Milton Friedmanesque, monetarist direction too. If the Federal Reserve had not been keeping money artificially cheap for the past couple of decades and it worked to lower interest rates and increase the availability of money in a given moment, that would mean one thing. Promising to keep rates low for the next couple of years – after years of loose money and statements that all those bubbles weren’t bubbles at all  – doesn’t mean the same thing.

Read the rest here.