There is so much wrong with the Senate Democrats’ new budget that it’s hard to know where to start. It does not fundamentally reform Medicare or other entitlement programs, it replaces the sequester, it raises taxes by almost $1 trillion, and more. As many have said before, the Senate Democrats’ budget is just a bunch of old and tired ideas that won’t seriously reduce our debt in the long run and certainly won’t help the economy.
But let’s focus on one the worst ideas in the budget: yet another attempt to stimulate the economy with spending, this time to the tune of $100 billion. The best we can say about the last attempt to stimulate the economy through government spending, the president’s 2009 stimulus package, is that it didn’t work as we were told it would. So why expect the same idea to actually work now? I can confidently predict that an increase in government spending won’t help the economy grow this time around either. In fact, after years of debate over the impact of government spending on economic growth, we don’t find much support for the effectiveness of this Keynesian strategy
First, in spite of what stimulus advocates continue to tell us, there is no academic consensus regarding the size or even the sign (plus or minus) of the multiplier used to calculate economic growth created by $1 in government spending. A review of the literature on the issue finds that the largest recent estimate is 3.7, while the smallest one is –2.88. However, on average, the multipliers are below “unity,” meaning that $1 in government purchases actually displaces private-sector economic activity, and the economy overall shrinks.
Better yet, in an excellent piece today regarding just this issue, Bloomberg columnist Caroline Baum explains how even the CBO in a recent report acknowledged that the ARRA (so-called stimulus bill of 2009) multiplier was 1. This means that the government spent $1 and that’s all we got, the government spending, with no additional economic growth in the private sector. She writes:
When the CBO examined the effects of various parts of the American Reinvestment and Recovery Act, the $830 billion fiscal stimulus enacted in 2009, it found the multiplier was about one: $1 of federal outlays bought $1 of GDP. Or, to put it in layman’s terms, there was nothing beyond the first-round effect.
Which shouldn’t be a big surprise. The nature of a balance- sheet recession and its residual of bad debt made deleveraging, not spending, a top priority for households and institutions. The multiplier can be affected by the level of interest rates, the kind of exchange-rate regime a country maintains, the degree of unutilized resources, and the amount of stimulus that was already put in place, according to economists Veronique de Rugy and Matthew Mitchell, senior research fellows at the Mercatus Center at George Mason University in Arlington, Virginia.
So during the deepest part of the last recession, the multiplier was 1. That’s pretty stunning, because Keynesian economics says that that’s the time when stimulus should produce biggest bang for the buck. The same was true in Europe during the recession — George Mason University’s Garett Jones had a great post a few weeks back where he looked at the estimated value of the multiplier during the recession in Europe. So, in the best-case scenario, government spending stimulated European economies about as much as it did the U.S. economy.
Now that we are not in a recession (though economic growth remains week), it will work even less. In addition, for Keynesian stimulus to be as effective as its advocates claim, it requires several conditions — most notably, the economy should be in a recession, the government should have low debt and/or no previous stimulus, and the stimulus measures must be “timely, targeted, and temporary.” As I have explained in my Washington Examiner column last week, this is more difficult than you may expect.
All this means that it is very hard to stimulate the economy with government spending. It didn’t work as advertised last time around, and it won’t work this time. In fact, there is a very strong case to be made that more government spending could shrink the economy.