Government Keynesian Based Stimulus Programs Didn't Work ... Why and So What?

Government officials view anything farther out than the next election cycle as the distant future and thus not relevant to today. That view is very much a wrong one.

What we elect to do today often has a large impact on what happens in the longer term. For example, the government stimulus spending programs of recent years will do considerable damage to our economy for years to come. The excessive accumulation of residential housing related debt will as well.

In the 1930s economist John Maynard Keynes argued that stimulating aggregate demand through government spending is the appropriate way to end a recession and resume solid economic growth. Our recent government intervention and stimulus programs were taken directly from the recessionary Keynes playbook.

But this time the plan didn't even come close to working as the Keynes model predicted. What happened?

In Four Reasons Keynesians Keep Getting It Wrong, economist Allan Meltzer addresses why the Keynesian approach is ill equipped to positively influence a secular debt driven recession and why its adoption was so wrong in the current recession. The evidence is overwhelming.

After three years and approximately one trillion dollars of government stimulus, unemployment remains at 9.1% and the economy is stalled. In fact, we have much higher unemployment and debt, along with greater fiscal deficits, than we did before we "fixed" things the Keynesian way. Thus, while we now know that the recent government stimulus programs simply didn't work, what may not be known is the longer term damage this government intervention has caused.

In Meltzer's view, the traditional Keynesian model contains harmful omissions:

"Why is the economic response to increased government spending so different from the response predicted by Keynesian models? What is missing from the models that makes their forecasts so inaccurate? Those should be the questions asked by both proponents and opponents of more government spending. Allow me to suggest four major omissions from Keynesian models:

First, big increases in spending and government deficits raise the prospect of future tax increases. Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will reach that conclusion by continuing to demand permanent tax increases. . . .

Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment. Keynesian theory argues that each dollar of government spending has a larger effect on output than a dollar of tax reduction. But in reality the reverse has proven true. Permanent tax reduction generates more expansion than increased government spending of the same dollars. I believe that the resulting difference in productivity is a main reason for the difference in results.

Third, Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy. Who can guess the size of the cost increases required by these programs? ObamaCare is not the only source of this uncertainty, though it makes a large contribution. We also have an excessively eager group of environmental regulators, protectors of labor unions, and financial regulators. Their decisions raise future costs and increase uncertainty. . . .

Fourth, U.S. fiscal and monetary policies are mainly directed at getting a near-term result. The estimated cost of new jobs in President Obama's latest jobs bill is at least $200,000 per job, based on administration estimates of the number of jobs and their cost. How can that appeal to the taxpayers who will pay those costs? Once the subsidies end, the jobs disappear—but the bonds that financed them remain and must be serviced. These medium and long-term effects are ignored in Keynesian models. Perhaps that's why estimates of the additional spending generated by Keynesian stimulus—the "multiplier effect"—have failed to live up to expectations."

When Keynes developed his thesis in the 1920s and 1930s, government spending was a very small part of the economy. Federal spending was ~3% of GDP compared a multiple of more than eight times that level, or ~25% currently.

In The Tale of the Dueling Economists, a book review about the opposing views of economists John Maynard Keynes and Friedrich Hayek, the reviewer has this to say:

"JOHN MAYNARD KEYNES and Friedrich Hayek. The names conjure opposing poles of thought about making economic policy: Keynes is often held up as the flag bearer of vigorous government intervention in the markets, while Hayek is regarded as the champion of laissez-faire capitalism. . . . This lively book explores one of the most pressing economic questions of our time: To what extent should government intervene in markets? And in that search, it traces the interaction of the two men most responsible for the way we approach this question: the British economist Keynes and the Austrian economist Hayek. . . . Thus, . . . the battle lines between Keynes and Hayek were drawn. Yet it was a duel characterized by mutual respect. Keynes, for example, shared Hayek’s distrust of socialism, while Hayek conceded that in the case of chronic unemployment, planning might play a role without leading to oppression."

And this is Keynes' view on the importance of personal freedom and democracy:

"Keynes didn’t expect that his findings would lead to an infringement of personal liberty. Instead, . . . Keynes believed “that a prosperous society in which everyone is employed was the surest way of maintaining the independence of thought and action he considered the guarantor of true democracy.”

So today we are left with high unemployment, huge deficits, growing government debt and a stalled economy. And a gloomy group of Americans concerned about the next generation's economic future. In my view, if we don't begin to seriously shrink the size of government and focus intensely on private sector growth, our nation's future well being is in jeopardy.

All that said, I also believe that most American citizens intuitively understand that the private sector is the economy's true growth engine, and that excessive government intervention will harm our nation's future growth, stability and security.

Simply stated, America's private sector performance in the face of global market competition will continue to represent our nation's only true source of competitive advantage in the world economy.

We must always keep in mind the important fact that economic progress is all about competition, innovation, entrepreneurialism, risk taking, hard work and free markets.

If as a nation we ever lose sight of how we became what we are and what's vitally important to our freedom and democracy, we'll begin to resemble everybody else, and then even our national security will be at risk.

It's really that serious.

Thanks. Bob.