Why Economic ‘Stimulus’ Only Makes The Economy Worse

Why Economic ‘Stimulus’ Only Makes The Economy Worse

While it remains a favorite policy prescription for politicians eager to appear as salvific heroes in times of need, it is untenable as a serious idea to stimulate anything except our national debt.
David Weinberger
By

As the global economy faces the prospect of recession, policymakers and politicians on both sides of the aisle have once again lined up behind Keynesian fiscal stimulus to deliver us from economic evil. But if the past is a guide, the likelihood of deliverance, to put it mildly, is not good.

John Maynard Keynes’s eponymous theory was published in 1936, at which point the Great Depression was several years old. However, President Franklin Roosevelt and Congress had already been injecting large dose

OK SEO score

s of Keynesian medicine into the ailing economy in the form of New Deal spending. The result was a protracted slump.

In fact, after eight years of furiously spending on a cacophony of government programs, unemployment remained in double digits, which led FDR’s New Deal architect and Treasury secretary, Henry Morgenthau, to admit defeat in 1939: “We have tried spending money. We are spending more than we have ever spent before and it does not work…I say after eight years of this Administration we have just as much unemployment as when we started….And an enormous debt to boot!”

Of course, today’s Keynesians scoff at the notion of defeat. They argue that the New Deal simply was not large enough, and that World War II spending provided the necessary jolt to end the depression.

There are two points in response. First, only superficially did the war “end the depression.” By any meaningful measure, it did no such thing. Second, leading Keynesian economists at the time, including Alvin Hansen and Paul Samuelson, predicted that the depression would return following the war’s end, once federal spending was cut.

In fact, reduced federal spending combined with the release of wartime command freed up resources in the economy, and private actors did not hesitate to respond. As a torrent of surging productivity unleashed an economic expansion, growth reverberated for decades, directly contradicting the Keynesian models.

Dumping Tax Money On the Economy Makes Things Worse

Furthermore, the years following that era only continued to discredit Keynesian theory. Prior to the 1970s, for example, Keynesian models posited an inverse relationship between inflation and unemployment—that is, high inflation meant low unemployment, and vice versa. The idea that the two could rise or fall simultaneously was, according to the model, an impossibility.

But that is precisely what materialized. High unemployment and inflation during the Jimmy Carter presidency became known as “stagflation,” and its persistence threw Keynesian theory into disrepute for the next 30 years.

Somewhat unexpectedly, however, Keynesian fiscal policy had a brief revival in 2001, after President George W. Bush used it to shape his tax rebate plan, and it experienced a complete resurrection in 2008 and 2009, when Presidents Bush and Obama both signed gargantuan “stimulus” bills targeting the demand side.

Unsurprisingly, all three bills failed to achieve their aims. For example, the 2009 stimulus architects assured that it would prevent unemployment from surpassing 8 percent. Unemployment in fact exceeded 10 percent—a full point higher than what the architects claimed would happen without stimulus.

It Doesn’t Work, But Politicians Don’t Care

In light of these numerous historical blunders, it is a wonder anyone takes Keynesian fiscal policy seriously anymore. Yet policymakers and politicians remain wedded to the model, as the current fury to rush through spending packages attests.

Now, lest the message here be misconstrued, this is not necessarily an argument against relief as a humanitarian measure in the midst of an economic meltdown resulting from governments around the world forcing businesses, communities, cities, states, and even entire countries to close down. This is a government-created economic disruption to deal with a public health concern.

Under these unique circumstances, there is certainly a case for providing targeted assistance. But we must not be fooled into believing that relief serves as economic “stimulus,” and nor can we ignore the fact that, beyond humanitarianism, there is no shortage of advocates calling for plain old demand-side fiscal stimulus. In that regard, there is little doubt that any Keynesian bill will blunt its drill on the same hard economic truth that stymied past demand-side exercises.

Instead of Spending, Target Production

The reality is that Keynesian policy fails for the simple reason that it targets the wrong problem. Production drives economic growth and creates an equal flow of demand. Demand is thus the consequence of production, not the other way around.

Successfully growing an economy, then, requires targeting production, not aggregate demand. Indeed, trying to grow the economy by targeting demand rather than production is like trying to grow a flower by watering its petals instead of its roots.

To better understand the futility of targeting aggregate demand, consider that any dollar the government spends must first be removed from the economy. That is, the government must take a dollar from Johnny Citizen — either through borrowing or taxation — before spending it. Government therefore displaces private spending dollar-for-dollar, meaning the net effect of a “fiscal stimulus” bill is at best zero.

That is because had the government not borrowed or taxed his dollar, Johnny would have spent it on a good or service. Of course, Johnny might have chosen to save his dollar by putting it in the bank. But even in that case, the bank would have lent it to someone else to spend, meaning all dollars — even savings in the bank — contribute to the economy.

People Saving Their Money Is a Good Thing

Of course, Keynesians argue that when people increase their savings simultaneously, as in a recession, government ought to spend to prop up the shortfall in demand. But even then, savings do not sit unused in a bank account, halting the flow of money described above.

Even in the rare case where people are hesitant to spend and banks are disinclined to loan, at the very least savings are invested in T-bills for government to spend, meaning that even increased aggregate savings do not interrupt the flow of money in the economy. Proof is in observing how hard financial markets work to earn interest on every dollar at every moment, meaning that virtually no dollars—savings or otherwise—sit idle.

Regrettably, though, widespread unfamiliarity with the historical record combined with confusion about the workings of the economy has allowed Keynesian fiscal policy to enjoy an undeserved renaissance in recent years. While it remains a favorite policy prescription for politicians eager to appear as salvific heroes in times of need, it is untenable as a serious idea to stimulate anything except our national debt.

David formerly worked at a public policy institution and is currently a freelance writer. In his free time he enjoys working out, reading nerdy subjects, cheering on Roger Federer, and playing "would you rather." Email him at [email protected] Follow him on Twitter @DWeinberger03.

Copyright © 2020 The Federalist, a wholly independent division of FDRLST Media, All Rights Reserved.