Could the majority be wrong?

Could the majority be wrong?
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First Published: Thu, Dec 18 2008. 10 27 PM IST

Updated: Thu, Dec 18 2008. 10 27 PM IST
More than 70 years after the ideas of a British economist were used to justify expansion in the?government’s role in the economy, John Maynard Keynes is back.
Almost everyone today agrees that a big fiscal stimulus is just what the doctor ordered to lift the US economy out of what is fast becoming the worst slump since the Great Depression. The few remaining limited-government types are hunkered down at Washington’s Cato Institute, a libertarian think tank.
The only questions for the Obama administration are the size of the package (anywhere from $500 billion-1 trillion, or Rs23.65-47.3 trillion) and its composition (infrastructure, tax cuts, transfers to the states, green jobs).
Economists always have facts and figures at the ready to justify new government spending. Mark Zandi, chief economist at Moody’s, assessed the impact of a $600 billion fiscal stimulus package, ranking various tax cuts and spending initiatives. Every dollar spent on food stamps and unemployment benefits yields a one-year increase in gross domestic product of $1.73 and $1.63, respectively, he says.
Recipients of government transfer payments are hard-pressed and will spend any financial aid very quickly, he adds. And that’s exactly what the Congress aims to do: put money in the pockets of people who will spend it.
Keynesian theory—the idea that the government can stimulate economic activity and reduce unemployment—provides the philosophical justification for spending other people’s money. There’s only one problem with the theory: a glaring logical fallacy, says Dan Mitchell, senior fellow at Cato. In the real world, government can’t inject money into the economy without first taking money out of the economy, he says. The theory only looks at half of the equation. The government can only spend if it borrows or taxes. Neither produces an increase in aggregate demand, Mitchell says. The pie is sliced differently, but it’s not any bigger.
If the government finances its spending by raising taxes, it transfers spending power from one group to another, says Paul Kasriel, director of economic research at Northern Trust Corp. in Chicago. If the government finances its spending by selling bonds, it transfers spending power from one entity to another.
Get ready for the but.
But if the government finances its spending by printing money, then no other group is induced to cut back on its spending, and there is a net increase in nominal spending, Kasriel says.
If the US Federal Reserve’s decision to cut its benchmark overnight rate to a range of 0-0.25% this week and its stated intention to use all available tools to keep its balance sheet at a high level are any guide, the Fed will be monetizing the debt, which is how we in the developed world refer to the crass act of printing money. The whirring sound of the printing press is hard to ignore. The Fed’s balance sheet, or the credit created by it, was equal to the amount of borrowing by the domestic non-financial sector in the third quarter of 2008 on a seasonally adjusted basis, Kasriel says. The Fed usually creates the seed money, with the banking system doing the rest.
This time around, the central bank created out of thin air the entire amount, which is unprecedented in the post-war period, he says. It may be unprecedented in the history of the Fed, but I don’t have data going back that far.
When the history of this crisis is written, the Fed’s role (monetizing the debt) will probably get lost amid the hosannas for fiscal stimulus.
Both the Democrats and the Republicans, who seem to have adopted big government as their own, are on board. Rare is the voice that objects to committing vast sums of money for a theory I thought was as dead as Keynes in the long run.
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First Published: Thu, Dec 18 2008. 10 27 PM IST