The ongoing debate over the proper amount and type of economic stimulus is heavily influenced by econometric models, which are used to simulate the effects on the economy of various policy alternatives such as tax rebates, tax rate reductions, and increases in government spending programs. These models all have one thing in common: the Keynesian emphasis on the primacy of spending. And once such models are accepted, their emphasis on demand sets the limits to the debate, regardless of the political persuasion of the participants.
The basic idea is that a government budget deficit leads to an increase in disposable income and, therefore, in consumer spending. The models assume that as long as there is unemployment or a growing labor force, output will rise to meet this additional demand. Thus, a deficit increases spending, which increases GNP and employment. The economic content of the models is captured by the oft-heard statement: “The reason people produce is that people buy.” In this view, a tax rebate and a permanent reduction in the personal income tax rate would both affect the economy in the same way, by increasing disposable income and total spending on goods and services.
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