Stimulus Spending Fails to Improve Economy

February 27, 2013

If studies on the short-run benefits of stimulus spending and the historical reality of public spending are examined, Keynesian macroeconomic policies that support stimulus spending make little sense, says Andrew Young, an associate professor of economics at West Virginia University.

  • The effectiveness of Keynesian increases in government expenditures are determined by fiscal multipliers, which denote how large the increase or decrease in economic activity is for each federal dollar spent.
  • Spending multipliers depend on an individual's marginal propensity to spend out of their incomes and their expectations of future tax liabilities.
  • When stimulus spending increases the deficit, individuals reasonably expect that the future tax liabilities of the deficit incurred will crowd out the benefits of any spending.

This means that for every dollar spent by the government, less than one dollar of economic activity is produced as market prices and market interest rates place downward pressures on consumers.

  • Because stimulus is the result of the political process and suffers from diminishing returns, it is unlikely to be targeted in the most efficient manner at areas of "slack" in the economy.
  • Mixed evidence from various studies suggests the spending multiplier is either greater or less than one, and most researchers, even those who support stimulus spending, acknowledge there are large long-run costs of deficit-financed fiscal stimulus.
  • When governments use aggressive fiscal policy they create significant macroeconomic instability.

Economic instability in the short-run creates a lack of consumer confidence, general uncertainty and lower investment and growth. In the long-run, ballooning debt-to-gross domestic product ratios will dampen growth and destabilize the economy.

  • Despite the scant evidence supporting fiscal stimulus, many politicians and pundits continue to call for increased government expenditures.
  • The American Jobs Act, supported by President Obama in 2011, detailed $447 billion in stimulus spending but was largely blocked by House Republicans.

Given the employment and economic record resulting from previous stimulus efforts, the wisest approach the government could take would involve putting away the credit card and ending further deficit-financed stimulus spending.

Source: Andrew Young, "Why in the World Are We All Keynesians Again?" Cato Institute, February 14, 2013.

 

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