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Hernando Today

The Paradox Of Keynesian Economics

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Hernando Today

Published: March 15, 2009

In his March 13 letter, Peter Stathis accuses me of saying deficit spending is bad when Republicans do it, but OK when President Barack Obama does it. Not true.

In my original letter I just set out, in very simple terms, the logic behind the America Recovery and Reinvestment Act, aka "the stimulus package."

During the Great Depression, an economist named Keynes wrote recessions are caused by "the paradox of thrift." Consumers are afraid to spend and investors are afraid to invest, so savings "leak out" of the economy. But more spending is just what the economy needs if it is going to recover. Unlike earlier economists, Keynes believed the economy could get stuck indefinitely in a recession.

For recovery to occur, Keynes reasoned, the government had to borrow enough money to close the gap between the actual GDP and the GDP needed to bring the economy to full employment. If the spending were directly financed through taxes, there would be no net gain in economic activity, so the government must operate at a deficit. That's the basic idea behind the stimulus package.

There are problems with that approach. As the economy recovers and approaches full employment, government borrowing "crowds out" private borrowing, so recovery slows. If government avoids that problem by creating money, inflation results. If government borrows from foreigners, the stream of interest payments leaks out of the United States into foreign economies, dampening American GDP.

Also, there is an opportunity cost to a large national debt. If we are paying hundreds of billions of dollars interest on the national debt, we are not using that income stream for other needs.

So Keynesians conclude that government should operate at deficit during a recession but balance the budget when the economy is at full employment and generate a surplus during inflationary periods.

Mr. Stathis also claims the Congressional Budget Office says the stimulus package will do nothing but waste money. Again not true. On the CBO's home page, you will find a letter to Sen. Chuck Grassley, R-Iowa, that outlines their forecasts as of March 2. The CBO says the economy will continue to contract through the third quarter of 2009 with or without the stimulus package.

But, with the ARRA, there will be between 900,000 and 2.3 million more jobs in fourth quarter of 2009 than there would otherwise be. In fourth quarter of 2010, there will be an additional 1.2 million to 3.6 million jobs, and an added 600,000 to 1.8 million jobs by fourth quarter of 2011. In other words, we will still have a long recession, but it will be much milder and the recovery quicker than otherwise.

To summarize, I believe the deficits run up during the past 30 years by Republican administrations have been mostly bad for the country. I am more pessimistic than the CBO about the depth and duration of the current recession, so I think the stimulus package is necessary, even given the enormous budget deficit that Obama inherited.

Dallas Dunlap

Brooksville

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