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The Case for No Stimulus


For the last three months, Americans have been treated to a debate over what the government can do to ease the effects of the current recession and bring about a speedy recovery. Lawmakers of both parties are now considering a very large stimulus package.

But there is a catch. Every penny of such a package must be borrowed, because the government is already running a $1.2 trillion deficit this year and faces a $703 billion deficit for next year, according to the non-partisan Congressional Budget Office. The question, then, is whether the government can help the economy by spending money if it can only do so by first sucking that money out of the economy. It is a question that surprisingly few public voices are expressing.

I spoke Monday with the Heritage Foundation’s leading budget analyst, Brian Riedl, about deficit spending as a silver bullet for ending recessions, and about whether the stimulus package now proposed is necessary or even helpful.

NRO: In this stimulus debate, no one is answering or even discussing an important question: Where is the money coming from? Can you stimulate the economy by spending money that you must first remove from the economy by borrowing?

Riedl: That is a great question. The grand Keynesian myth is that you can spend money and thereby increase demand. And it’s a myth because Congress does not have a vault of money to distribute in the economy. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. You’re not creating new demand, you’re just transferring it from one group of people to another. If Washington borrows the money from domestic lenders, then investment spending falls, dollar for dollar. If they borrow the money from foreigners, say from China, then net exports drop dollar for dollar, because the balance of payments must adjust. Therefore, again, there is no net increase in aggregate demand. It just means that one group of people has $800 billion less to spend, and the government has $800 billion more to spend.

NRO: There is also much talk about the difference between saving and spending. Politicians from both parties are talking about savings as if it were a bad thing, and the need to make people spend as much as possible right away, as though that can save the economy. But is there any difference in economic impact if I spend money now, or if I put it in a bank account?

Riedl: There is this notion that the redistribution of money from savers to spenders creates new spending. But that assumes that people store their savings in their mattresses. That may have been true in the 1930s, but today, people use their savings to pay down debts or invest. Or they put it into the bank, who in turn lends it to others to spend. Therefore, savings circulate through the investment side of the economy, which counts just as much in the GDP as the consumption side of the economy. So even the saving versus spending distinction doesn’t make any sense.

The simple fact is that the only way to create economic growth is to increase productivity. Redistributing money from one group of people to another doesn’t create productivity or economic growth.

NRO: When government borrows $800 billion, it has to lure that same amount of investors’ money out of the economy, does it not? Away from investments in businesses, and into safe, low-yield bonds?

Riedl: The government is going to have to raise interest rates in order to convince people to lend them the full amount they need. We’re already facing a deficit of $1.2 trillion this year, and 700 billion next year. We borrowed $700 billion for TARP, and now we’re going to borrow $800 billion for this stimulus package. Compare those numbers to the entire public debt, which was 5.8 trillion up until a few months ago. It’s going to be very difficult for a global economy, which is already in a recession, to supply the U.S. government with [$3 trillion] in new borrowing. Right now, a lot of banks are happy to buy Treasury bonds because they are safe investments . . . but overall, that may not be enough. The government may have to raise interest rates higher and higher and higher in order to persuade people to lend their diminishing savings to the government. And that’s going to hurt the economy for a long time.

NRO: So we’re actually going to pay to induce people not to invest in the economy, to hide their money in government bonds instead.

Riedl: Exactly. There’s only so much savings to go around in the private economy. Every dollar of savings that government snatches up through borrowing is one dollar of savings less to be invested in businesses that create jobs. It’s one dollar less to expand new technologies. And so there’s a real danger that the economy is going to suffer long-term because it’s not going to have the investment capital to create productivity and jobs, because Washington is gobbling up all the savings for their own spending.

NRO: Explain to me the “multiplier effect” that we’ve been hearing about–this idea that if the government spends a dollar on food stamps, it helps the economy grow by $1.50. Just assuming that there’s some level at which this works, is my money less valuable to the economy if it’s saved in a bank than it is if it’s taken or borrowed from me and spent on food stamps?

Riedl: The multiplier is based on the idea that money will circulate through the economy faster as long as you don’t have savings being chopped off with each transaction along the way. But again, savings do not fall out of the economy. They pay down debts, they go into investments, or they go into banks, and in each case the money ends up being spent somewhere else. The multiplier is roughly the same regardless of who is spending the money. If you spend the money at a restaurant, you begin the same spending chain as if the government spent the money on someone on unemployment benefits . . . If you put your money in the bank, the bank will lend the vast majority of it to others to spend, or else they will invest it in Treasury bonds, thus lending it to the government to spend. So the multiplier is roughly the same, whether you spend the dollar yourself or you put it through the bank and they give it to somebody else to spend.

NRO: But there is actually a difference between investments and food stamps, isn’t there? Even if you can help people individually in the short run, you don’t increase productivity by giving people food stamps?

Riedl: Yes. In the long term, economic growth depends on productivity growth. And that depends on whether we’re using some of our money to create jobs, capital and technology that allows the economy to grow in the future. If you believe that the private sector is better at spending money to create investment and productivity than government, then letting individuals keep more of the money they earn, in the long run, will increase the economy’s capacity to produce wealth. For that reason, we should be encouraging people to save rather than to consume. Savings goes into investment spending, which helps the economy grow more in the long run by giving us more tools to create wealth . . .

You’re better off in the long run with investments. That’s why the government policy right now–borrowing money out of savings and investment and putting it into consumption–will not only be zero sum in the short run, but it will actually reduce our long-run capacity for growth.

NRO: There are some things the government can provide that would actually improve the economy–say, if they build new and badly needed roads, or a new electrical grid that allows us to deliver electricity better and more cheaply. But the benefit of such investments would be years away, would they not? The immediate act of having the government borrow money and hire people–that does not necessarily create any jobs, does it?

Riedl: That’s exactly right. In the long run, the existence of a strong infrastructure with highways that allow the transport of goods and services, can help the economy grow . . . But in the short run, the act of spending $1 billion on highways does not stimulate the economy. The 34,000 highway workers that receive that billion dollars are receiving a billion dollars that had to be borrowed out of the private economy, which in turn lost the same amount of money and thus is able to support fewer jobs for now . . . So when you borrow and spend that money, you’ve just shifted jobs from one part of the economy to the other.

NRO: During the first six years of the Bush administration, Republican Congresses ran enormous deficits, and the government hired lots of workers and contractors with that money. No one suggested then that it was a boon for the economy. And if we’ve been running such big deficits, why hasn’t all that deficit spending helped the economy?

Riedl: Exactly–and in fact, when the government ran budget surpluses at the end of the 1990s, that didn’t hurt the economy. Money didn’t fall out of the economy because Washington used the budget surplus to put that money back into the economy by paying down debts and giving that money back to bond-holders. Similarly, when the government went into deficit all throughout the Bush term, economic nirvana was not created. The supposed parallel between budget deficits stimulating economic demand and growth has not been proven at all . . . Lawmakers keep passing the same bills with the same approach. We passed the $168 billion stimulus last year with the rebate checks, and the economy didn’t grow after that, either. But it’s as if every failure of government spending to increase economic growth is taken as proof that Washington didn’t spend enough. They never take a look at a new approach.

NRO: At the moment, everyone seems to be saying we need to pass something, and quickly. But the implication of what you’re saying is that the one thing fiscal policy is incapable of affecting is our short-run economic situation.

Riedl: It cannot affect short-term demand. Passing nothing would be better than passing a stimulus package, because not only will the stimulus package not increase aggregate demand, but it’s also going to raise interest rates, which will weaken the economy even more over the long term. The better approach, if we’re going to go $800 billion into debt, would be to cut marginal tax rates. Cutting marginal tax rates increases incentives to work, save, and invest, and the resulting change in behavior increases productivity.

Tax cuts do not work simply because they put money in people’s pockets–that would just be the flip-side of the government spending argument. Even the money for tax cuts just has to be balanced either by less government spending or by more borrowing. The important thing is the incentives created, the change in behavior. That is why we talk about cutting marginal rates . . .

NRO: Why is no one else asking this question of where the money for the stimulus comes from? The Financial Times urges passage of this bill. Everyone on Capitol Hill, Republicans included, argue that we need something. Is our conversation here just crazy talk? Does anyone care where the money comes from?

Riedl: I’m not sure why economists haven’t been pointing this out . . . For politicians, though, it’s much more understandable. Keynesian economics offers the promise of a free lunch. It offers the idea that government can wave a magic wand, spend money, and make the recession end in a pain-free way. It’s just not that easy.


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