Keynes, stimulus, why it hasn't worked!!

Jun. 27, 2012


Why hasn't the current economic stimulus yielded the results everyone hoped would be achieved???? I hope I can help shed some light on the problem.

     First, let us understand that poor John Maynard Keynes has been misinterpreted and used as the focus for all kinds of well intentioned economic policies that have no basis in his aggregate demand stimulus theories. Non-academics and unfortunately some academics have assumed that Keynes "demand stimulus" theories meant that the government should spend money to shift aggregate demand. Theoretically, the infusion of government spending would cause the multiplicative effect to give the economy a jump start and rejuvenate economic growth. Unfortunately, this is a simplistic view which "cherry picks" his theory. Keynes stressed that it was not only necessary to inject through government spending but that it required a balance by reducing taxes. No-one mentions the second step. In fact Keynes actually supported the concepts later proposed by the "Laffer curve".

     It is sometimes beneficial to view the theory from the view of someone who has an infection. The doctor will give an injected antibiotic to shock the system and begin recovery but then prescribes long term antibiotics taken orally. Government stimulus spending should always be quickly spent and directed toward capital development that will yield long term returns. Then, tax policy has to be established that will encourage the market to invest and continue expansion.

     Now, this primer leads us to the basic question, WHY HASN'T THE STIMULUS WORKED. Understand that both President Bush's and President O'Bama's intentions were well founded; they hoped to keep the economy from deteriorating further and begin recovery. Having said that, both were essentially flawed and have resulted in "kicking the can down the road".

     First, bailing out any entity, when done by the government will always be the least efficient way of resolving the problem. It will result in maintaining a structurally inefficient entity for the sake of avoiding a short term agony. Now we might choose to do this but we must recognize that then the problem must remain in focus and corrected. When both Presidents said that the "bundled equity" problem in housing couldn't be forecasted they are both misinformed and wrong. I have a 1983 textbook in finance that specifically warns of the potential for exactly what occurred. Saving Fannie Mae, Freddie Mac, and the "too big to fail" banks has merely expended large amounts of the American treasure without resolving the underlying problem.

     Second, The stimulus plan was even more flawed. Where the TARP expenditures could have provided temporary relief while the problem was being fixed. The stimulus was poorly designed and basically flawed. IF the stimulus was to work it had to be quickly injected and used for capital asset development. The rapid injection would boost or sustain the economy while the capital asset development would provide jobs with duration and a long range economic boost. Therefore, the expenditures needed to be aimed at those projects that would, without a doubt, yield long term economic growth.

     Third, and probably one of the most serious errors, is the fact that the stimulus needed to stimulate the aggregate demand curve. Now be careful, this doesn't mean "spend money". The expenditures must be designed to rapidly stimulate growth and development. In this aspect the program caused its own failure. Nowhere in Keynes theories does he propose "creating demand". Demand is a function of individual preference which includes a desire to own, a willingness to purchase, and the ability to make the purchase. Economic policy should not be used, especially in an emergency, to attempt to develop a demand for specific products in order to pursue a social agenda. The reason this is true is that it is: 1. Not guaranteed to work. 2. Most assuredly going to take time which is a critical element in getting the economy back on track. 3. Neglects the already developed structure that can yield long term benefits. Creating demand is a marketing function not an economic function. Stimulus has to be short term and immediate and to be successful it must be directed at the demand curve. The aggregate demand curve reflects those actions where participants have the desire, willingness, and ability to purchase and the stimulus must encourage them to do so.

     By directing the stimulus at unemployment, food stamps, education, and a myriad of alternative energy proposals the administration placed itself in a position of inevitable failure. The long term social crutches like unemployment have to end sometime which will cause a shock to the economy. Education yields no short term benefit. The alternative energy investments are an attempt to address social issues by "Creating demand". Remember, the goal is a quick "shot in the arm" and Creating Demand is not an economic function it is a marketing function which takes time that is not available if we want to correct the lagging economy.

     OK, I know when I said "education" I pushed your buttons. Well, the administration knew this also. By directing $$$$ at education they can gain public approval. The problem with this is that, once an economy has sufficiently educated its populace to meet its normal needs increasing the educational numbers is ineffective. It is at this point that the growth will only be achieved by "exceptionalizing" the educational system. In short, providing intensive education to the top academics so that the next generation replacements are superior to their predecessors. Simply, throwing money at achieving more graduates is not expanding your human capital assets it is merely developing more of the same. I might recommend reading Rameriz,etal for those more interested in this subject.

 Student Achievement and National Economic Growth

Author(s): Francisco O. Ramirez, Xiaowei Luo, Evan Schofer, John W. Meyer

Source: American Journal of Education, Vol. 113, No. 1 (November 2006), pp. 1-29

Published by: The University of Chicago Press

     Now, what is truly ludicrous is when the administration proposes "alleviating the college debt". These individuals are still injecting their earnings into the system. Admittedly they aren't seeing the use of the money but it is circulating. Alleviating their debt is merely giving them more of the money which belongs in the system to allow others to borrow. Additionally, this will not expand the education base even though the first blush reaction is to say that this is good as it addresses education. NO it doesn't-- it addresses debt.

     Well, I could go on about the errors in the stimulus plan but that is probably enough controversial material for today.