Thursday, May 21, 2009

Fiscal stimulus doesn't work!

All politicians and all high school students (and anyone else who thinks that government can fine-tune economic growth) should be required to look at and think about this chart. What it demonstrates is that government "stimulus" plans which take money from one person and give it to another have absolutely no impact on the economy. The silver lining to the current economic cloud is that we are accumulating plenty of evidence, such as this, that Keynesian economics is not only devoid of logic but devoid of results. Can we now drive a stake through the heart of this miserable beast? (HT: Mark Perry.) I have to repeat part of his post if only to ensure that this bit of valuable wisdom is disseminated as widely as possible.

The Economic Stimulus Act of 2008 passed in February. The major part of this package was to send cash totaling over $100 billion to individuals and families in the United States so they would have more to spend and thus jump-start consumption and the economy. Most of the checks were sent in May, June, and July. As would be predicted by the permanent income theory of consumption, people spent little if anything of the temporary rebate, and consumption was not jump-started as had been hoped.

... formal statistical work shows that the rebates had no statistically significant increase in consumption.

~From Stanford professor John Taylor's paper "The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong" (HT: Lee Coppock)


Gene Prescott said...

Since there wasn't a spike in consumption, was there a spike in something else? Savings, debt reduction, etc.

Bernard said...

I 100% agree. Cutting stimulus checks does nothing for the economy in the long run but add more debt and itnerest payments.

Scott Grannis said...

Gene, you are obviously correct. The extra money received was undoubtedly used to increase savings and/or pay down debt. Deleveraging has been all the rage.

ChronicleSmith said...

My sense has always been that Keynesian economics is, fundamentally, an accounting gimmick.

Scott Grannis said...

Your intuition was right on the mark.

Tom Burger said...

Chronicle Smith,

Keynesian economics is worse than that, by far. Try reading Hazlitt's "The Failure of the 'New Economics'."

Keynes' General Theory is a profoundly bad book by just about any standard you want to use. He changes definitions without notice, uses non-standard and confusing terminology for no reason, writes silly mathematical equations that serve to obscure rather than to inform, fails to apply simple rules of logic, ... It goes on and on.

On top of that, it is just tragically stupid and fails to apply elementary economic principles. Some of his supporters have said things almost this harsh!

Another Hazlitt book is "The Critics of Keynesian Economics" -- this is simply a compilation of other people's papers making many of these points.

That latter book contains a Frank Knight article he wrote not long after Keynes' General Theory was published. At one point he said "... my difficulty (and no little annoyance) has been choosing between interpretations, one apparently nonsensical and the other more or less commonplace."

The real point of Keynes' book was apparently to tell governments exactly what they wanted to hear, and to provide theoretical "cover" for things like the "socialization of investment" and other grand expansions of government power.

In the German language edition of the General Theory, Keynes himself said in the preface that his theories would be more easily implemented in a totalitarian political environment.

Scott Grannis said...

Keynes was one of the worst things to happen to capitalism and free markets. Keynesianism and the Phillips Curve will unfortunately continue to haunt us for many years to come. I wish someone could find the silver stake to kill these monsters once and for all.

STS said...

That wasn't fiscal stimulus it was a rebate on taxes. All it proved was that temporary, token-sized tax cuts have no impact. Big deal.

Mark A. Sadowski said...

The fiscal multiplier of a temporary across the board rebate of income taxes is...., well...,almost zero. All this proves is what New Keynesian economists have been saying for nearly thirty years now is absolutely true. If you want to stimulate aggregate demand you have to make sure it is spent. There are only two ways of doing this: direct government expenditures or direct transfers to those with low incomes.

Another way of looking at this is the following: tax cuts don't do diddly squat.

Scott Grannis said...

STS: The reason these "tax cuts" didn't work was because they weren't tax cuts, they were rebates. They didn't change anyone's incentive to work or risk more. They just took money out of one person's pocket and put it into another's.

Scott Grannis said...

Mark: The only way you can stimulate aggregate demand is to first stimulate aggregate supply. That can be accomplished by changing the incentives to work, risk, and invest. It can't happen by seizing money from people and spending it.

Mark A. Sadowski said...

The only way you can stimulate aggregate demand is by making sure the money is actually spent. Cutting the rates on capital gains and dividends in 2001-2003 was supposed to generate an unprecedented boom because it was supposed to alter the incentives to work, risk, and invest. It has been an unmittigated and abismal failure. It's time you gave up your pagan faith that is without basis in reason and unproven by the empirical facts.

Scott Grannis said...

Mark: If there were logic to your statement, then we could spend our way to prosperity. We could confiscate money from half of the people give it to the other half and order that they spend it. But obviously if we did that there would be no growth. Growth comes from spending money in a productive fashion (i.e., from investment). You need more investment and risk taking to grow the economy. The tax cuts of 2003 did exactly that, as a boom followed. The problems of last year had nothing to do with your alleged failure of tax cuts.

STS said...

So we agree that rebates don't help. My point was that rebates aren't "fiscal stimulus" in the Keynesian sense. Maybe to the majorities in Congress who passed President Bush's "stimulus package" last year it was a fiscal stimulus, but they just completely missed the point.

The same observation applies slightly differently to the tax cutting part of the Obama stimulus package which the Republican caucuses were so proud of insisting on.

The point of deficit spending as stimulus is for the government to act as "investor of last resort" (like the central bank role as "lender of last resort") in a situation in which the private sector is in an irrational panic and everyone is afraid to take any risk. If the private sector is contracting rapidly, then the government can (at least partially) stem the tide by going ahead with infrastructure investments that needed to be made by government anyway. (Obviously the Obama stimulus package didn't hit that mark squarely.)

In the long run, your argument about "confiscating" money and just moving it around makes sense. But Keynes' key point was that the state is uniquely positioned to tow the economy out of a ditch caused by temporary market failure.

You may be thinking: "that tow truck pushed us into the ditch, why would we want its help?" But if the tow truck is the only alternative, does it really matter who put you in the ditch? Get out of the ditch and *then* replace the driver ;)

Of course most Keynes-haters don't believe economic ditches exist. Economies never get really "stuck". I think they did in the 1930s, and blame games about bad trade and monetary policy don't really disprove that.

Nobody can really prove we are TODAY "stuck" in this particular "we need the state to drag us out of it" sense, so it's best to just leave it there: You say KEENES, I say KANES, let's call the whole thing off!

Scott Grannis said...

You make a lot of good points, and I don't have any fundamental disagreement with you. I really like the tow truck analogy.

Mark A. Sadowski said...

If there was any real logic to your statement there would have been a boom following Bush's deficit bloating tax cuts of 2001-2003. Quite simply there wasn't. Even before the free fall in economic activity this had been the worst seven/eight year period in economic activity (job growth, median earnings etc.) in our nations's history. That was a boom only if you were taking hallucinogens and wearing rose colored Californian glasses.

Scott Grannis said...

In the first 5 quarters of the recovery following the 2001 recession, real GDP grew at only a 1.7% annual rate. Then real GDP grew at a 3.5% annual rate for the three-year period ending March 2006. That counts as a boom for me, and I would add that real GDP grew at a 7.5% rate in the quarter that followed the Bush tax cuts of 2003.

The economy weakened starting in the second quarter of 2006 because the housing bubble began deflating.