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June 03, 2011


Neal Patterson


I enjoy your Rate Watch emails very much.

I really wonder if it is ever correct to say, "Keynesian deficit spending is of value...". As a nation we do pretty well at spending. There are still plenty of maxed-out people around.

When government borrows and spends, at the very least, this is disrespectful of my time preference for spending. The government is spending my money NOW and assuring me of a future tax increase - which makes me feel less secure and less inclined to spend. Also, it seems to me that, to some extent, every dollar spent now is one that cannot be spent in the future. Isn't all this current spending a kind of feasting on the "seed corn" of future economic activity? Thanks.

Dick Lepre


Great question. Let me make two points first. 1) Every economics student had been taught that Keynesian spending is good and 2) the attitude toward Keynes' notions about spending are largely split by political preference.

Keynes basic notion was, I think, sound: the economy goes through cycles and when the economic activity of consumers and investors abates the government should spend in and increase spending to prop up the economy.

Keynesian spending is of value if and only if is cascades. That is, if and only if the dollars spend by the government expenience a "money multiplier" are are spent again and again.

The problem is that the Great Recession was not a garden variety economic down cycle. It resulted from a real estate bubble which affected the banking system. Real estate debt is highly leveraged unlike, say, the dot-com bubble. Collapse of the value of that which is highly leveraged has a mopre pervasive effect. This happened to Japan more than 20 years ago and they still have not recovered.

Keynesian deficit spending may work best for infrastructure and we may have painted ourselved into a corner with too muck environmental regulation making WPA-like infrastructure spending impossible.

The 2009 stimulus was aimed more at supporting state and local governments and had too little to seed real recovery.

Borrom line is that Keynesian spending makes sense if it pays for itself with expanded GDP and tax revenue without tax increases. It is becoming obvious that this did not happen with the 2009 stimulus.

Worse yet, we have enormous structural deficits from Social Security, Medicare and Medicaid which have never been properly funded. In short we have two problems: structural deficits and cyclic deficits.

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