Killing Keynes & Krugman Part 3: Flaws of Stimulus By Rick Kelo

Killing Keynes & Krugman Part 3: Flaws of Stimulus

By Rick Kelo

Keynes' Flaws of Government Action in a Recession = Pandora's Box

This article is the third in a six part series.  I am writing these articles in layman's terms so any non-economist can easily follow along. They will break out as follows: 

1. Examples of Keynesian failures
2. Keynes' Flaws of Government Action in a Recession
3. Flaws of Stimulus
4. Government vs. Unemployment
5. Keynesian Bubble Creation
6. Keynes' Flaws of Government Action in an Expanding Economy (AKA Clintonomics)

2. The Flaw of Stimulus Spending

I am going to lead off by suggesting to you that employment vs unemployment is not the real issue in stimulus spending.  The real issue is whether tacking government spending onto GDP through borrowing actually fixes the economy (hint: it doesn't).

When the economy goes through a down cycle Keynes suggests government spend money it doesn't have in order to make up for the lost spending.  The basic gist of this idea is that government puts money in the hands of people who spend it.  Of course in every recession beforehand when government did not do this unemployment & economic growth recovered very rapidly within a few quarters.  That is something Keynesians would prefer you to forget though.

There are several major flaws in this theory:

First, the government can't put money into the economy without first taking it out of the economy in the form of either borrowing or reducing the value of the money by printing more of it.  The stimulus approach is just like scooping water from one side of the bathtub and dumping it on the other side.  You haven't made the tub any fuller.  It doesn't actually make any net change in what Keynes called aggregate demand.

Second, there is not a government on this Earth with its own money. There is no government with a surplus set aside to spend in a down economy.  There are only governments in debt.  So the only money a government can spend is money it first takes from its citizens.

Third, in order to believe huge government stimulus spending works you have to make some very BIG assumption like the one's made by both Keynes & Paul Krugman (Keynes last remaining disciple of any consequence).  These theories state that every dollar spent by the government creates a dollar of either consumer or investment spending.  We know that is not the case.  We saw it happen when Bush's rebate checks were almost all spent to pay down debt or used for the single one thing Keynes hated most: Savings!

 we have an excess of desired savings over desired investment — that’s why the economy is depressed!
~ Paul Krugman, Feb 14th, 2013 (Source)

Of course everyone knows there is not a stagnant economy due to people saving their money.  Rather people are saving their money due to a stagnant economy.  And that money being saved did not disappear from the economy like Krugman implies.  It is in the banking system allowing much larger loans that fund investment projects to be issued against it elsewhere in the economy.

But Keynes saw savings & investment as two different things; Krugman is just parroting his master.  Except they aren't different.  All investments come from savings.  The distinction was only important to Keynes because, in order to work, his theory required that everyone spend everything they have and then spend more based on debt.  He advocated this for government's quite obviously, but he also advocated it for individuals.  Keynes hated savings so much he felt you should earn no interest on your savings account, and if possible be charged a negative interest rate by your bank and have to PAY to save your money because you were engaged in the bad behavior of refusing to spend.

Keynes wrote in near gibberish so this will be very wordy.  You will hear him refer to interest on savings as a "cost" that reduces the churn & burn cycle of spending every penny you get.  In turn the business who gets your money must spend every penny they get to put a new inventory item on the store shelf to replace the one you just bought.

- "date of input" = the day you get a dollar.
- "date of consumption" = the day you spend your dollar (if "you" are a business the day you use that dollar to make whatever it is you sell).
- "length of process" = how long it takes you to spend a dollar after you get it.
- "interest" is interest on a bank account.  A dollar saved is not spent, and the problem as Keynes saw it was increasing spending.

 If the rate of interest were zero, there would be an optimum interval for any given article between the average date of input and the date of consumption.

If, however, the rate of interest exceeds zero, a new element of cost is introduced which increases with the length of the process.

if the rate of interest falls below zero the opposite is the case.  [C]urrent input will only be worth while when the greater cheapness is insufficient to offset the smaller return from negative interest.  In the case of the great majority of articles it would involve great technical inefficiency to start up their input more than a very modest length of time ahead of their prospective consumption.

Thus even if the rate of interest is zero, there is a strict limit to the proportion of prospective consumers' demand which it is profitable to begin providing for in advance
~ John Maynard Keynes,  The General Theory of Employment, Interest, and Money,  p.137

Keynes hated savings and saw it as the refusal to spend.  Most of his ideas about stimulus spending stem from the notion that it is better to get that money in the hands of consumers & boost consumer spending than to have it sit idle.  Except that money being saved isn't sitting idle.  Its in a fractional reserve banking system allowing investments to be made and loans to be written.

It is the inherent unsoundness of Keynes' theories that leaves Keynesian economists like Paul Krugman forced to peddle excuses for its failures.  The primary excuse is that the stimulus was too small.  This illogical, heads-I-win-tails-you-lose defense, Krugman has repeated countless times after its failure (Sources: 1, 2, 3)

It wasn't too small, the reality is that no amount of stimulus will improve an economy in the long term.  Simply borrowing money from one area of the economy & putting it in another area of the economy does not make your economy any larger.  Krugman is not alone in hiding behind this excuse for the failure of Keynesianism.  He's also 65 years too late.  That excuse was used the first time those same ideas failed when a decade of massive application of Keynesian stimulus failed to cure the the Great Depression.  

It is significant to recall that the first definite and conscious application of the theory was made by the New Deal; and when in the third year Mr. Roosevelt began to say that the government's deficit spending must be regarded as an investment in the country's future, he was taking the word directly from the Keynes theory. The promised results did not follow; unemployment was not cured. This disappointment, say the believers, was owing to no fault of the theory but simply and only to the fact that the deficit spending did not go far enough. ~ Garet Garrett, American Affairs, Volume VIII, #3 (July 1946)