How Keynesian stimulus is supposed to work Tom Smith

Well, here is one cogent-seeming explanation that is in accord with what I remember from years ago.  I'm afraid I really only understand Keynesian stimulus policy at the level of crude metaphor.  The economy is like a man on a bicycle.  If the bicycle slows down too much, he enters into an unstable disequilibrium.  He will slow down more and more, get tippier and tippier, until he falls over.  That's the collapse at the end of a deflationary spiral.  What he needs is a good shove, so he can get pedalling again and back into a stable equilibrium at a higher speed.  (I know I should not be educating myself in public in this way, but academics who pretend they know everything are so unbelievably tedious that I decided long ago to fess up to my ignorance, unless there was truly a lot to gain by not doing so.)

My problem is I don't quite believe it, Keynesianism that is.  One thing I certainly don't believe is that the government is likely to make productive investments with their stimulating spending.  I suspect it will be like a lewd dance by an ugly person.  It may be intended to stimulate, but will fail to do so.  

The Agonist blog post also says that the idea is to recapture with taxes enough from the increased production caused by the stimulus to pay back the stimulus.  To that I say, ho ho.  It is very hard even for the really smart people with the new technology and all that, to make money.  For the government to do so by throwing money at failed business models and dreaming up some new ones of their own, such as "green technology", strikes me as a very long bet indeed.  Last night on XPR, they were talking about how Congress was going to spend 150 to 300 billion on green technology.  I am very confident that most of this, if it is spent, will be wasted.  By drawing all sorts of engineers, managers and so on into businesses that ultimately don't work as businesses, it will be enormously costly, more so than whatever is wasted outright.  I suppose some of it will come back beneficially as demand from the salaries to engineers trying to invent new batteries or whatever.  But huge amounts will be wasted.  There won't be much increase in production from these investments to tax and repay the borrowings that finance it.  When a business does this, it goes bankrupt.  When a whole economy does it, I doubt it works out well in the end.

So I take it the path we have already embarked upon is to borrow trillions of dollars to spend on projects many of which will be flat out waste.  Not just the coming green rapture, but Citibank, GM and the rest.  I concede I don't really understand how Keynesian stimulus is supposed to work, but I just don't find the story very persuasive or encouraging.  I just don't see how making bad investments on a sufficiently large scale can make them pay for themselves.  I suspect a hidden (often anyway) premise in the Keynesian story is the assumption that governments will find productive things to do with the money they borrow and spend.  That I really don't believe.  To get through this, I fear we are going to need the kind of stimulus that comes in bottles.

Comments

[nathan zuckerman]

Since the nation is now in very deep trouble economically, it seems only wise to see if that both parties now seem to agree upon will perhaps work.
What do you offer as an alternative? Instead of predicting what you think may not work why not offer some solutions that differ from what we have been doing? Seems to me you are much like the football enthisat who believes he knows more than the coach or the players or the managers but who sits and drinks his beer while condemning any and all plays.

[mr burns]

The suggestions as to what will work are as obvious as they are painful . We have to give up the idea that we can consume our way to prosperity . It doesnt work for individuals and it wont work for countries either . Eventually the checks bounce and your credit gets cut off (see Iceland)

When malls become factories, diversity trainers become janitors, and we stop spending hundreds of millions trying to replace all use of the words "husband" and "wife" by "partner A" and "partner B" then there may be hope.

It wouldnt hurt to have a commodity based money . You could actually save money and not have it depreciate into garbage by the time you retired.
The government would be constrained in it's spending which should limit the damage the bozos can do.

Finally any institution that is too big to fail is too big and needs to be broken up.

I'm not holding my breath on any of these. Consequently the possibility of hyperinflatary destruction of the USA within the next 2 years is real.

[K T Cat]

Keynesian economics in a very small nutshell: In good times, the government should run a surplus or at least balance the budget and pay off any debts. In bad times, it's OK to run up the debt in order to keep people working. Under no circumstances should you debauch the currency by printing money.

We never balance the budget (except when Congress was managed by Newt Gingrich, God bless him) and we're currently monetizing the debt - debauching the currency. Keynes lived in a world with much smaller governments and much smaller government debts. Even if we followed it, I'm not certain his theories apply any more. I've been exploring this on my own blog.

[AntiCitizenOne]

Actually Keynesian Stimuloss will cause a depression.

Firstly the excess government borrowing will tend to crowd out private borrowing.

Secondly the existence of loss making entities in the financial system will lower growth still further, and prevent the re-allocation of assets to profitable endeavours.

Thirdly taxes or inflation will have to be higher in the future and both damage the economy.

The root cause of all this is because the government mismanaged its currency monopoly and created far too much credit, leading to vast malinvestments and rent-seeking throughout the economy. These have to be removed and bank reserves rebuilt over time.

[mockmook]

In theory, if an economy has seized up, the government could spend on things we need (things that have real/proven value): infrastructure, food, housing.

Green tech could fit the bill if, for example, a solar array could produce power at prices competitive with other sources.

The trick I guess (assuming a seized up economy), is getting the government out of the way once businesses start spending again.

BTW, deficit spending does create money (because the Fed buys some of the government debt, i.e., prints money).

[mockmook]

Someone can correct me if I'm wrong:

It appears the Fed is buying bank debt (and other "assets"), hence printing physical/electronic (deposit) money.

There is also destruction of M1 type money because of the bank crisis.

Will the Fed be able or willing to destroy physical money at an appropriate rate once M1 bounces back?

[bobby b]

"Will the Fed be able or willing to destroy physical money at an appropriate rate once M1 bounces back?"
- - -

Sure.

Yours and mine.

[franglo]

"The lewd dance of an ugly person" -- the new tagline for this blog, perhaps.

[Ric Locke]

Re: Keynesian economics -- you have it almost correct.

The theory derives from the observation of boom-bust cycles. It states that, during booms, the Government should tax heavily, in order to pay off debt of course, but more importantly to take some of the pressure out of the bubble. Then, during a bust, Government should spend to prevent letting all the air out.

It has never been tried in practice. What generally goes under the name of "Keynesianism" is simple debasement of the currency, in order to create inflation and make debt easier to recycle. If John M. were still here he would be suing people for taking his name in vain.

Regards,
Ric

[Fat Man]

We got into this mess by borrowing and spending. We are broke and we are not going to get out the mess by more borrowing and spending. We are going to have to hitch up our big boy pants and save for a change.

"Dying of Consumption" by Stephen S. Roach in the NYTimes on November 28, 2008"
nytimes.com/2008/11/28/opinion/28roach.html