Monday, September 21, 2009

The wierd legacy of the Bush administration...

...was to rehabilitate Keynes as a justification for bigger government.   Instead of incentives, Bush used "stimulus" as a justificaiton for his 2008 tax cut.  However, as the below graph illustrates, the tax cut did not have the expected "multiplier" effect on consumption that Keynes' model would predict.

For a more detailed critique, check out
John Cochrane's essay:
Most fiscal stimulus arguments suffer from three basic fallacies.
First, if money is not going to be printed, it has to come from somewhere. ... Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. ... But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes. Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.

Finally, I am not even sure that Keynes would have been convinced that Keynesian stimulus was a good idea (Via ThinkMarkets):
Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.

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