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Why Keynesian “stimulus” bills do not, and cannot, work

April 2, 2009 · Filed under: Politics
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This is quite simply the best explanation I have ever seen for why Keynesian government “stimulus” efforts do not — indeed, cannot — actually achieve anything like what they set out to achieve:

I had never heard of Cato’s Dan Mitchell before, but this video suggests he is a very gifted communicator, not unlike Daniel Hannan. YouTube turns up many more gems from Mitchell, including a discussion with Neil Cavuto of Obama’s inevitable massive attack on middle class taxpayers and a discussion of tax haven myths.

In a similar vein, Jeffrey Miron explains what the Obama team would have done if they really wanted to stimulate the economy — eliminate the corporate income tax:

Recent estimates by Christina Romer, the head of Obama’s Council of Economic Advisers, suggest that tax cuts have a multiplier of three, meaning that repeal would increase GDP by roughly $1 trillion. By comparison, the administration’s assumption that the government spending multiplier is about 1.5 suggests that the $500 billion in the Obama stimulus package would increase GDP by about $750 billion.

Note also that the “first” multiple — any multiple of one — is a wash. This means that if tax cuts stimulate the economy by a factor of three, and government spending stimulates the economy by a factor of 1.5, then the tax cut would be not two times but four times more effective than the government spending.

(And that factor of 1.5 is, as many economists have noted, rather optimistic indeed. It may be simply another case of what is seen and what is not seen.)

If even the head of Obama’s Council of Economic advisors says that a tax cut stimulates the economy four times more than does government spending, then what exactly does it tell us that they proceeded instead with government spending?

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  • http://joeduarte.blogspot.com Joe

    Word up. Similarly, http://joeduarte.blogspot.com/ 2009/04/money-doesnt-come-from-outer-space.html

    And I’ve always been confused by the multiplier effect, and how it’s used in economic arguments.

  • http://fixnwrtr.blogspot.com J. M. Cornwell

    If Keynesian doesn’t work and it’s all about the government getting bigger and spending money, then why do they keep point to Roosevelt’s administration to show that it does work when it obviously doesn’t? Roosevelt had longer than any other president and the numbers do not support his “phenomenal” administration.

  • Austen

    http://www.econtalk.org/ archives/2009/01/ fazzari_on_keyn.html

    Here’s a good discussion of the Keynesian argument for stimulus, especially the “paradox of thrift”. The Keynesian view might be problematic, but I think most free-market types don’t really understand it. Government stimulus probably hurts more than it helps, but the risk of “liquidity traps” seems to me at least a legitimate concern.

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