The basic Keynesian stimulus argument goes something like this: If the US federal government engages in deficit spending during a recession, the added government expenditures (unaccompanied by tax increases) will boost “aggregate demand.” Greater federal spending on a road, for instance, will create jobs for construction workers, who can then spend their additional income on, say, bread. Bakers now will have more to spend on, say, cars and so on, says Richard B. McKenzie, a professor in the Merage School of Business at the University of California, Irvine.
National income stimulated by the initial government road project can grow by some multiple of the expenditure, Keynes’ theory says. A stimulus package (and budget deficit) of $1 trillion would morph into a minimum of $1.5 trillion in additional national income maybe even into $4 trillion or $10 trillion.
But if it sounds too good to be true, it is, says McKenzie.
As economist Milton Friedman observed, when the government engages in deficit spending, it must borrow the extra funds from someone who could have spent them on private-sector projects. Thus, an increase in government spending could be totally offset by a decrease in private spending, as lendable funds are diverted from private to government uses. The net effect can be no net increase in aggregate demand and no multiplier effect. Indeed, with the inevitable waste in government stimulus projects, the multiplier effect could as easily be negative as positive, says McKenzie.
Source: Richard B. McKenzie, John Maynard Keynes, R.I.P., Freeman, October 2010.
For text: http://www.thefreemanonline.org/featured/john-maynard-keynes-r-i-p/#
For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17
First published by the National Center for Policy Analysis, United States
FMF Policy Bulletin/ 05 October 2010
