Stimulus, Spending and Animal Spirits: How to Grow the Economy

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The most fanatical Keynesians are losing their composure. Brad DeLong, a prominent Berkeley economist and Keynesian, is virtually yelling that “We Need Bigger Deficits Now!”, emphasis his. Paul Krugman does DeLong one better, calling proponents of fiscal responsibility madmen.

They are following the gospel of John Maynard Keynes, who famously advocated government deficits to pay people to dig holes, increasing demand and therefore economic activity. This is, to be polite, bunk.

It is worse than that actually. The logic implies that any government expenditure funded by debt will result in sustained economic growth. The result has been a stimulus plan that completely lacks coherence. Instead, we have a hodgepodge of spending initiatives that provide a temporary illusion of growth, but that will leave us with little that is long-term, except for huge hangover of debt which will be a drag on economic activity for years.

Keynesian stimulus theory comes about because of what is called a liquidity trap, a situation where the interest rate is zero, because no one wants to invest. The logic is that you can spend your way out of a liquidity trap; that by spending, government can increase sales. Eventually the increased sales will cause businesses to invest, driving interest rates up.

It is an article of faith among Keynesian economists that if the stimulus is big enough, it will generate sustained long-term growth. Call this the Tinkerbell Principle. You only have to believe in animal spirits to have expectations of a better future.

Consequently, when the spending doesn’t achieve the desired result, Keynesians always call for more deficit spending, just as we see in the above-linked DeLong and Krugman arguments. And, when that doesn’t work, like a broken record, they will call for more, but there can never be enough.

There is a case to be made for expectations, but they need to be rational. The recession was similar to a bank run, which can kill a bank, even when there is no initial weakness to generate the run. In this case, we had a run on the world’s financial system. Call it a regime shift from a good equilibrium to a bad equilibrium.

Can government spending alone bring us back to a good equilibrium? It can if you believe in animal spirits, but I don’t.

I believe that people are not excessively stupid. Economists call this concept rational expectations, the idea that most people can see obvious consequences most of the time.

I believe that people spend out of wealth: the value of the assets they hold and the present value of future income. This may not be an easily calculated number, but people keep track of it. It is something like a fielder's response when a batter hits a ball. This is a complex problem, but fielders respond instantly. The fielders are moving in the correct direction at the correct speed to intercept the ball while the bat is still in motion.

Finally, I believe that people try to smooth consumption. That is, they like to eat a little every day rather than go without for several days and binge on other days.

Let’s analyze typical deficit-financed government spending programs using these beliefs. Somebody is going to have to repay the debt someday. It can be the person who receives the money, some other person who is currently working, or some future worker.

If the person who receives the money is the one who must repay it, she will normally save it. Her wealth has not changed, she knows that she will have to repay the money, and she’s not excessively stupid. She’ll want the money there when she needs it. We saw this with the Bush “tax rebates.” Consumers saved the rebates, and the administration did not see the consumption boost they had anticipated.

There is another possibility though. She could be what we call 'liquidity constrained', holding no cash and unable to borrow. Her wealth is still unchanged, but she wants to smooth consumption — keep it at a relatively steady level — so she may spend some or all of the money. However, this implies that her future spending stream will be reduced. We’re taking from tomorrow’s economy to support spending today. This may be justifiable on humanitarian grounds, but it doesn’t generate sustained long-term economic growth.

Suppose it is another worker who will repay the government debt. His wealth has just decreased. He’ll spend less, and, also being a consumption smoother, he’ll start spending less right now. Again, there is nothing here to generate sustained long-term economic growth.

Finally, suppose it is some future worker who will repay the debt. He or she will enter life or the workforce with a debt. I'll ignore the ethical implications of enabling increased consumption by current citizens by imposing, without consent, debt on future workers; instead, I'll stick just to the economics.

Our future worker starts a career, absent some other endowment, with a negative net worth. Over the course of his career he'll spend and invest less than if he had started with a zero net worth. Again, this is not a prescription for sustained long-term economic growth.

What we have to face is that by borrowing to consume now, we are taking away from the future. This is just not the way to achieve sustained long-term economic growth.

So what to do if you are a politician who thinks something must be done?

The liquidity trap comes about because no one wants to invest. What government should do in response is try to increase demand for investment. This would increase economic activity now and in the future. Increased demand for investment can be created by investing in public capital that makes private capital more productive, and by lowering the cost of borrowing.

When the government borrows and invests the money in projects that increase private capital’s productivity, it is increasing the return to capital. Increasing returns to private capital increases the demand for private capital and investment. Current and future economic activity is increased.

We have lots of examples of these types of investments, including canals, dams, highways, public utilities like the Tennessee Valley Authority, and more.

The other approach to increasing investment is to lower the interest rate. This is difficult to do directly when the interest rate is zero, but the government can achieve the same result another way. An investment tax credit effectively lowers investors’ borrowing costs.

So, if the government is going to actively stimulate the economy, it would be far better to invest in public capital that improves the returns to private capital. It will also help to provide a meaningful investment tax credit. Consumers could then rationally expect their future income stream, hence their wealth, to improve. With increased wealth their spending will increase, and we will be on our way to sustained long-term economic growth.

Flickr photo "Búho Real" by sıɐԀ ɹǝıʌɐſ

Bill Watkins is a professor at California Lutheran University and runs the Center for Economic Research and Forecasting, which can be found at

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Animal Economy

Animal economic value and the endorsement of chemical fertilizers to do more production it is very difficult to get the proper food for animals. People are keeping animal and birds as the form of business purpose. In so many books you can get the information how to take proper care about the animals as well as you can visit Emergency Vet chatsworth for better information. The experienced are providing the latest information's regarding the care of animals.

Self Contradictory

"What government should do in response is try to increase demand for investment. This would increase economic activity now and in the future....When the government borrows and invests the money in projects that increase private capital’s productivity, it is increasing the return to capital....We have lots of examples of these types of investments, including canals, dams, highways, public utilities like the Tennessee Valley Authority, and more."

I fail to see how that isn't classically Keynesian. I mean, you spent the entire article talking about how government spending can't sustain long term growth and then you give an example of how it can (and did with the TVA).

Also, the US government can still borrow cheaply. The best way to decrease the debt in the future isn't to "impose [it] on future workers," it's to pay the 1% interest for a few decades while we have 2% inflation and 3% growth (or hopefully better). All of a sudden, that debt isn't such a big deal. That's what happened after we borrowed for World War II and after we borrowed to pay for Reagan's tax cuts, both acts of which took us out of recessions.

The Republicans Forced Clinton To Balance The Budget

Many people seem to forget that Bill Clinton tried to pass Hillary Care that would've erased any surpluses that he likes to take credit for. When Hillary Care went under, the republicans with the help of Newt Gingrich and his contract with America came into power. Bill Clinton had no choice but to balance the budget if he wanted to get anything through a republican dominated congress. He did raise taxes, but let us not forget he also cut spending (Welfare Reform). He also helped his surplus by raiding Social Security as well as cutting up the military.

On the other hand, Bush did cut taxes, but he did not cut spending. He spent like a mad man. You cannot cut taxes and increase spending at the same time, that is not good economic policy.


I think Clinton benefited from an explosion in the computer industry. I worked at a computer retailer from 93 to 97 and things really took off in this time frame.
Personally, though voting Republican before the last election, I am disgusted by Bush. I thought the Iraq invasion was pure stupidity, and the spending was so hypocritical with all the Republican talk of fiscal responsibility.
Well here comes Obama, mentioning fiscal responsibility, and he is a Democrat. I also learn that in recent history, Democrats have actually done better than Republicans regarding deficit spending, making Republicans sound even more hypocritical to me.
What does Obama do? After all the irresponsibility of the Bush spending spree? He doubles down on it?!?! I have become convinced that the Democrats and Republicans as a rule are two sides of the same coin.

Higher Taxes + Controlled Spending in 90s Grew Economy

No Free Market Republican or Keynesian has ever explained to me why the economy took off after Bill Clinton raised taxes and reduced the rate of growth in spending. Or why GW Bush cut taxes and increased the rate of growth in spending, and economic growth was anemic. I remember all the panicking in 1993 that the combination of higher taxes and the peace dividend would crush the economy - right before we started creating 2-3 million private sector jobs a year.

Hard data defies both the tax cutters and the deficit spenders. Big problem with the Keynesians is they think it's 1933, and fail to realize that the cost of hiring has gone up faster than inflation, especially when health benefits are factored in. Henry Ford's $5 a day at the Model T plant would be worth $26,000 a year now, barely enough to cover health insurance, never mind pay a salary.

As a result of higher labor costs, far fewer jobs get created from a stimulus as we've seen over the last year. Moreover, with a savings rate increasing, you can't throw money at people by endlessly extending unemployment benefits.

Government austerity in the 90s served us well, because it left the private sector alone to grow the economy, yet higher marginal tax rates did not stunt economic growth as Phil Gramm, Larry Kudlow, and others said they would. Problem in economics is Keynesians, Austrians, Monetarists, etc are all in love and invested in their theories, and are unable to reconsider when the data proves them wrong. So in 2010, I'm a hard core anti-Krugman Austerian, but wouldn't have been 80 years ago.