We Can’t Even BEGIN to Debate Keynesian Stimulus Until We Know the Facts

Keynesians argue that we must increase fiscal stimulus to prevent a full-scale depression.

They argue that “deficit hawks” are wrong when they say that we can’t afford any more stimulus, and that worrying about debt in a crisis of this size is penny wise and pound foolish, given the bleak unemployment figures and other fundamentals. They also point out that America’s debt as a percentage of GDP is far less than Japan’s.

On the other hand, those worried about the giant debt overhang argue that massive debt and the failure to write down worthless assets and “purge malinvestments” from the system are the main problems.

Many also argue that the 1930s Keynesian stimulus programs did not work, and that the Depression did not end until World War II. And they also argue that every dollar in additional debt incurred now is another burden added to our childrens’ shoulders.

Who is right?

Before deciding, you might want to look at two pieces of data.

Different Bangs for the Buck

Initially, many Keynesian academics argue that it doesn’t matter where the stimulus money is spent, just as long as it is spent on something. However, this is untrue. For example, it should be obvious that spending in some areas will have more and quicker turnover (increasing money velocity) as compared to others. And, in fact, economists have documented that some types of stimulus spending have more bang for the buck than others.

So it is idiotic to talk about “fiscal spending” in the abstract. Without a cost-benefit analysis as to each category of proposed spending, any analysis is hollow.

Aggressive Fiscal Stimulus Only Buys Two Quarters

Moreover, as former chief IMF economist and MIT professor Simon Johnson points out:

Perhaps the best analysis regarding the impact of fiscal policy on recessions was done by the IMF. In their retrospective study of financial crises across countries, they found that nations with “aggressive fiscal stimulus” policies tended to get out of recessions 2 quarters earlier than those without aggressive policies. This is a striking conclusion – should we (or anyone) really increase our deficit further and build up more debt (domestic and foreign) in order to avoid 2 extra quarters of contraction?

Indeed, many experts say that continuing to cover-up the fraud which led to the financial crisis will extend the crisis for many years. In other words, failure to investigate and prosecute those responsible for bringing about the crisis may extend the crisis longer than any failure to spend more on stimulus.

(And investigations and prosecutions for fraud – unlike stimulus spending – would not increase America’s debt or tax burden.)

A real debate about whether we should spend more on stimulus – and if so, what types of stimulus – cannot even begin unless and until the aforementioned data is considered.

Note: Others have calculated bang for the buck from stimulus packages. For example, here are the Congressional Budget Office‘s estimates (look for “Estimated Policy Multiplier”):

Cbo2

Cbo3


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