The first stimulus package didn’t work so apparently we need another one. Of course, President Obama will not say that his $787 billion stimulus package failed. He is simply calling for another one with an estimated price tag of $180 billion. President Obama’s second stimulus package would include investment in infrastructure projects and tax breaks for middle-class families and businesses, which would give failed Keynesian economic theory yet another undeserved shot.
Keynesian theory assumes that a negative economic event leaves demand significantly below supply. If the event is severe enough, demand would remain below supply for a substantial amount of time during which businesses cut production to meet supply causing the economy to contract. To prevent a deep economic contraction, the government should inject fiscal stimulus into the economy. Theoretically, the stimulus funds end up in the pockets of consumers who would purchase supply thereby stimulating and stabilizing the economy.
Keynesian theory predicts that government stimuli have a multiplier effect on the economy of about 1.5. That is, for every dollar the government injects into the economy, economic growth would be $1.50. The evidence suggests otherwise as Keynesian economics have been tried several times without successful outcomes.
Although its acceptance has sputtered a few times over the years, Keynesian economic theory has persisted for eight decades since its application during the Great Depression. It didn’t work then and it has not worked during the decades since.
Why has the theory persisted if it hasn’t worked?
First, President Roosevelt’s leadership and resolve during World War II was admirable. He made tough decisions as commander-in-chief and the Allies won the war. Second, he died while serving his fourth term in office near the end of WWII. American’s tend to fondly remember their presidents who died in office. Finally, leftists blamed capitalism and big business for the failures of Keynesian theory during the Great Depression.
Big government leftists insist that the government, directed by the right people, can and should solve economic and societal problems. Implicit in this idea is the notion that citizens cannot be trusted to solve their own issues. Leftists argue that big business held the Great Depression economy captive and would not release it. Like President Obama, FDR’s egotism prevented him from recognizing that his policies failed. Also like President Obama, FDR demanded more government intervention in the economy via stimuli and regulations after previous stimuli and regulations failed.
Although it took about nine years after FDR took office, the Great Depression ended when he was president so conventional wisdom assumes that his policies ended it. Many people, however, do not consider FDR’s nine years of failed fiscal policy prior to the US buildup to WWII. They simply assume that his Keynesian policies must have ended the Great Depression since he was president when it ended. In fact, it was only when FDR reversed his policies and pulled the government out of the economy when the US prepared for war that the Great Depression ended.
The legacy of FDR’s big government Keynesian policies has persisted because conventional wisdom incorrectly interprets the efficacy of Keynesian policies during the Great Depression. Many people simply do not understand the complexity of the Great Depression. Leftist political elites take advantage of this ignorant conventional wisdom during times of economic uncertainty and use it for their own political expediency.
Modern Keynesians, like President Obama’s former chief economic advisor Christina Romer, get one thing correct in their theory. They argue for tax breaks along with stimulus spending. Tax breaks are the only sound fiscal policy in modern Keynesian theory.
Tax breaks for middle class families and businesses are an acceptable and proven means to stimulate economic activity. Investment in infrastructure projects, however, would provide little to no economic stimulus yet add to the already offensively high federal deficit.
One only needs to point to two recent events to dispel the myth that Keynesian stimuli provide any meaningful boost to the economy. First, Japan’s lost decade from the early 1990s to the early 2000s. Japan suffered a severe negative economic event when its real estate market collapsed in the early 1990s. Japan entered into an economic recession and responded with a stimulus package. The stimulus package failed so Japan tried another stimulus package, which also failed. Overall, Japan tried ten stimulus packages over eight years. None of them provided substantive long-term economic stability or growth. Japan spent over $1 trillion during its lost decade accumulating a public debt that was 130 percent of GDP without stabilizing the economy.
Second, the Obama stimulus package. President Obama argued that $787 billion stimulus would create millions of jobs effectively ending the recession. The Obama administration argued that unemployment would not surpass 8 percent with the stimulus package. The current unemployment rate is 9.6 percent. The GDP grew temporarily but its growth rate is slowing once again causing consternation among Obama’s team. Judging the stimulus package by the Obama administration’s own benchmarks, it was an epic failure.
Why don’t fiscal stimuli work?
As Brian Riedl of the Heritage Foundation argued in his backgrounder Why Government Spending Does Not Stimulate Economic Growth: Answering the Critics, stimulus packages don’t add new money to the economy. The economic monetary base does not expand via stimulus packages. Governments must borrow or tax money out of the economy prior to injecting that money back into the economy. Taxing redistributes money from one part of the economy to another. Domestic borrowing from investors shifts investment from the private sector to the public sector. As for borrowing from foreigners, Riedl stated that “If [Congress] borrow[s] the money from foreigners, the balance of payments will adjust by equally raising net imports, leaving total demand and output unchanged.”
Riedl explained stimulus spending this way, “Removing water from one end of a swimming pool and pouring it into the other end will not raise the overall water level.”
President Obama should not allow his ego and ideology to cloud his judgment on the efficacy of stimulus spending. The federal budget deficit is already far too high adding to a public debt that is nearing unmanageable levels. If President Obama won’t listen to pragmatic moderates and Conservatives, he should listen to the European leaders asking him to curb America’s deficit spending.
It is morally objectionable that President Obama insists on using federal deficit spending to apply failed leftist theories to the current economic situation since future generations will be responsible to repay the debt. President Obama and the leftist leadership are stealing from our posterity.
