Monday, March 9, 2009

Can the Government Stimulate the Economy?

If two conservative economists discussed whether fiscal stimulus can ever work, and one exposed the debate as irrelevant to our current crisis, would the other even notice?

The answer seems to be no. Russell Roberts gives what he apparently believes is a deep and philosophical critique of Keynsian spending, arguing that government spending (G) effects consumption (C) and investment (I), such that an increase in G will lead to a decrease in C and I; they are more or less zero sum. Robert's argument rests on the assumption that an increase in G necessitates higher taxes, which individuals and businesses will factor into their spending and investment decisions, offsetting the effect of any higher government spending. This is recycled Treasury view masquerading as insight.

But then Arnold Kling exposes one of the fundamental flaws of the Treasury view: it assumes something close to full employment. When the economy is near full capacity, government deficits more or less would crowd out private investment. But when resources are being unemployed, this does not apply. And today we certainly have idles resources, between private capital sitting on the sidelines, pouring into short-term Treasuries, and unemployment itself rising above the equilibrium level.

Roberts seems oblivious to the implications of Kling's argument. The Dark Ages are quite dark, indeed.

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