The Fatal Flaw of Keynesian Stimulus

Article excerpt


Last week, the Congressional Budget Office released a report claiming that the $814 billion stimulus has added 3.4 million net jobs. This surely comes as a surprise to the 3.5 million Americans who have lost their jobs and remained unemployed since the stimulus was enacted in February 2009.

Such implausible analysis does not come from actually observing the post-stimulus economy. Rather, it comes from Keynesian economic models that have been programmed to conclude that government spending injects new dollars into the economy, thereby increasing demand and spurring economic growth. In other words, these models are programmed to conclude that stimulus spending always creates jobs and growth, no matter how the economy actually performs.

But there is one problem with the government stimulus theory: No one asks where Congress got the money it spends.

Congress does not have a vault of money waiting to be distributed. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another.

It is intuitive that government spending financed by taxes merely redistributes existing dollars. Yet spending financed by borrowing also redistributes existing dollars today. The fact that borrowed dollars (unlike taxes) will be repaid some years later does not change that.

Some believe stimulus spending is the mechanism by which the Federal Reserve injects new dollars into the economy. Yet the Fed could run the printing press and then inject those dollars into the economy by buying existing bonds (with mostly inflationary results). It doesn't need an expensive stimulus bill to conduct monetary policy.

Before spending $814 billion on the stimulus, Congress had to borrow it from some combination of the following three sources:

* Foreign countries. Government spending funded from foreign borrowing is no free lunch. Before China can lend America dollars, it must acquire them by running a trade surplus (which is a trade deficit for America). For example, American consumers spend dollars on Chinese imports (reducing America's gross domestic product), and then China lends those dollars to the U.S. government to spend (increasing America's GDP). The increased trade deficit exactly offsets the stimulus spending, leaving a net GDP impact of zero.

* Savers/investors. Much government spending is financed by borrowing from banks, businesses and individuals seeking a safe place to park their savings. Keynesian economics downplays savings - as if they fall out of the economy - and believes government can increase demand by borrowing and spending those savings.

In reality, savings do not fall out of the economy. They are invested, or deposited in banks that quickly lend them to others to spend. The financial markets exist to convert one person's savings into another person's spending. …