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Econ 101: Obama’s Keynesian Economy

March 4, 2011

Obama’s Keynesian Economy

There is major disagreement between two groups of economist on how the economy works. On one side, there are classical economists, championed from the Austrian School and the University of Chicago, who believe that unregulated markets are inherently self-stabilizing and that government intervention does more harm than good.

On the other side, is Keynesian economist, such as Nobel laureate and NYT’s columnist Paul Krugman, who believe that market systems needs a little help and intervention from government. A central tenet of the classical view, states, “supply creates its own demand”. A central tenet of the Keynesian economics propagates Government role in lifting demand.

Classical economics teaches that if there’s a downturn, the economy will eventually sort itself out. If people aren’t buying enough, prices will drop to a point where people start spending. The public doesn’t look to the government to prop up spending. Keynes’ believers insist that sometimes things don’t right themselves. The economy goes into a downward spiral. The usual dynamic of supply and demand breaks down, people don’t spend enough money, and there’s no way for the economy to automatically adjust. So, Keynesian prescription theorizes, that if all else fails, the government should spend the money.

In short, Keynesianism has two sides: increase government spending during a downturn to artificially stimulate demand and then save during the fat years so as to have money available to stimulate employment during the lean ones. Yet, the theoretical possibility of ‘saving for a rainy day’ never occurs in practice. Why? Because if the government is taking in exceeding tax receipts that it has a surplus, the right will argue for tax cuts, the left for more social spending.

The Keynesian formula is fairly straightforward. First, you estimate how much the economy ‘should be producing’ — given all the people, factories, and offices. Lets say $15 trillion. Then you look at what the economy is ‘actually producing’. Let’s say $14 trillion. The Keynesian theory is government shouldn’t have to spend the entire trillion-dollar shortfall. That’s because of something called the “Keynesian multiplier.” Every dollar the government spends produces more than a dollar in spending throughout the economy and, in turn, a greater increase in national income.

For example, if the government pays you to build a bridge, you spend your paycheck on rent and food and so on, and then your landlord and grocer have money, they spend it, etc, etc, etc. Using Keynesian math, you could pretty much estimate exactly how much the Obama administration would seek to spend in stimulus. And, Voila! Obama’s stimulus was $787 billion. The “Keynesian multiplier” makes up the difference towards the $1 Trillion plus dollars through economic ‘activity’.

But, the claimed additional economic benefit from government spending simply never materializes. And, Obama’s entire economic plan is grounded in the belief that massive new government spending is the key to economic recovery. But to spend, you have to tax small businesses, corporations, and all Americans. And, economies simply don’t recover while staring down the barrel of a 12-gauge tax hike.

Democrats and/or Progressives never figure into their calculations the decrease in activity of an increased tax on that activity. To note: Tax incentives (cuts) have a higher ‘multiplier’ than government spending (increases). What is multiplier? It is the amount of new economic activity generated by $1 of stimulus determined by either tax cuts or spending increases. A lower multiplier is bad. A higher multiplier is good.

Spending impacts die faster than tax cuts. Tax cuts impact growth and sustains them greater over a period of time. Because the stimulus package focused on spending and not tax relief the long-term stimulus multiplier will be much lower; resulting in a limited long-term impact on the economy; as we have witnessed.

There are no ‘controlled experiments’ when dealing with the economy. And Obama’s massive stimulus package was the first real world test. But in reality, the stimulus failed and massive government spending has produced higher deficits. If you tax, the dollar the government spends is a dollar some taxpayer couldn’t spend in the economy. If you borrow, the dollar the government spends is a dollar that wasn’t available for someone else to borrow.

Government spending does NOT “pump new money into the economy” because government must first ‘tax or borrow’ that money out of the economy.  So, once it becomes clear that government spending only redistributes existing demand, the case for “stimulus“ spending collapses.  All government stimulus spending requires first taxing or borrowing dollars that would have otherwise been applied elsewhere to the benefit of the economy.

If you “print money,” there’s more money chasing the same amount of goods, so prices go up (“inflation”) and the dollars are worth less. So people spend more “dollars” but they can’t actually buy more stuff, since prices are higher. So the increase in government spending is canceled out by a decrease in the purchasing power of all the money in circulation, so there is still no actual stimulus. There is no “Keynesian multiplier.”

Every dollar the government spends is a dollar someone else did not spend. But it’s actually worse than that, because taxation, borrowing, or inflation is itself costly. They distort incentives and complicate business and personal financial planning – so the spending reduction by taxpayers is actually MORE than the amount spent by the government… Still, the White House does believe in Keynesian economics. And to that, I say, welcome to Ferris Beuller’s day off as the leader of the free world.

The Keynesian model is flawed.  The result is vicious inflation, a bloated government, economic contraction, and trillions of dollars in debt as a constraining burden on Americans’ children. Obama’s stimulus and massive spending has completely failed to create any jobs and prescribing Keynesianism to some politicians is like prescribing crack to a coke addict.

This entire deteriorating economic outlook has undermined business confidence. Fear of implementation of ObamaCare. New EPA rulings. Ban on oil drilling. Spiraling debt. Real Estate Foreclosures. Bank failures. Increase in oil and energy prices. Falling dollar. Higher shipping and transport cost. Consumer confidence down.

All of this has paralyzed economic recovery as business leaders hold off on ‘new investments’ and corporate leaders ‘wait and see’ what next mandate is handed down from Washington. It takes capital to produce, grow and create jobs and U.S. money managers alone are safeguarding over two Trillion dollars in investment capital as it sits on the sideline.

This government “activism,” including fiscal stimulus, unemployment payments, mandates and arbitrary regulations, housing subsidies, and stalled credit creation in the capital markets is holding back the economic recovery. Government debt is the only thing growing. Yet, it is mathematically impossible to get out of a credit recession with more debt.

All the while Obama’s government is “cooking the books” on the unemployment numbers and current inflation rates. They are making their own rules on how to determine inflation rates by leaving out essential information such as ‘food and fuel’ prices.

And, as inflation increases, the Fed will push interest rates up eventually, in order to keep oil and other commodity prices down since they are tied to the dollar. As the interest rates start to increase, the economy here in the U.S. will go even further into tailspin.

The same is being done with White House unemployment numbers (where even their revised numbers are outright lies) by simply leaving out those who have given up looking for jobs. Real unemployment is 17+%.

Modern-day Keynesianism allows them to look busy during a crisis and act as though they’re, well, acting. It also allows politicians to get their hands on a lot of redistributive cash — and that allows them to share the spoils with key backers and constituents. It’s practically built for pork. Perhaps even more seductively, it gives politicians the illusion of control over the economy, allowing them to pick winners and losers.

Unfortunately, that is just an illusion; as Hayek explains in ‘The Road to Serfdom,’ the economy is too complicated for central controllers to operate it, and those attempts to do so result in economic ruin. We are under attack by our federal government. Obama’s economic team of born-again Keynesian central planners has failed.

This is Obama’s Keynesian Economy.

6 Comments leave one →
  1. pals permalink
    March 14, 2011 7:35 pm

    You would probably do better arguing with people on forums than writing articles on a blog no one reads.

  2. Joe R permalink
    March 15, 2011 1:08 am

    Kelly,

    You know as well as I do that neo-Keynesians / Socialists never learn. They chronically see people as 1 of 320 million, rather than 1 person. They believe guiding people “in the right direction” trumps the rational thought of people through their day to day life, and they hold on to their economic views no matter how simple they are to debunk (from “tax cuts to the rich” to broken window fallacies).

    The fact is, the liberals in America are worse than what they have in Europe. In places like Sweden, at least they’ve realized a welfare state can only exist if everyone’s paying into it. Liberals here just want to piggy back on those that earn, and could not care less about looking at the data that shows why that is ineffective.

  3. John T. Baty permalink
    March 23, 2011 11:07 am

    Read your stuff was really impressed by your grasp of Keynes and the Austrian School of Economics. Unfortunately, it is time to move on from these very outdated ideas. Both deal with the pre WW2 world, and I am also amazed that someone of your obvious intelligence can really give any credibility to “The Road to Serfdom” much less adopt it as treatise on twenty-first century economics.
    A couple of other points, Can you explain the role of government in our lives? Is government really necessary? If you agree that some government is needed, then how much and who should pay for it?
    I think that you would probably want to have some sort of police and fire protection to insure safety for you and your family. So if there was a crime wave where people’s property was being taken away from them, would you support paying for more police and prosecutors to protect your property?
    1. Do you support government programs for crop insurance, flood insurance and disaster recovery?
    2. Do you support government spending for defense?
    Just a couple of things for you to think about – If you ponder this for a while – you’ll likely come to realize that some government is necessary. The real question is how much.
    Moving on now – Free Market Capitalism – “Unregulated Markets”
    What would be the value of Apple or Microsoft stock if intellectual properties were not regulated? So would you agree that a truly unregulated market place would be better if all such governmental protections were eliminated? It would certainly bring down the cost of the IPAD with the Chinese and other Asian clones flooding the marketplace. But that would only offset the true cost of gasoline had “Standard Oil” evolved into the only source in the world.
    Impact of Obama Economic Stimulus – No Impact.
    In my cul-de-sac, three primary income earners lost their jobs due to the financial crises. All three were earning over $100K. One was in Telecom the other two were in Finance. Not a lot of jobs popped up for them in the newspaper right away. All three received extended unemployment benefits from the stimulus. None of their homes went into foreclosure. This certainly protected the value of our homes. The class size in our schools remained at 19-20, without the stimulus funding given to our state; many teachers would have had to go – more foreclosures – worse education.
    Your Economic Model – Government Spending and Inflation
    The problem with your economic model is that you don’t seem to understand the value of government. The United States of America is clearly the best government the world has ever seen, but it doesn’t come free. Hayek was looking at the thirties when he wrote “The Road to Serfdom.” This was certainly a period of economic history that was much less regulated than we are now. You talk about spending and inflation and the money supply in today’s world and use Hayek as a basis. You’re right about the thirties – there wasn’t any inflation. The problem was there wasn’t any money (currency.) I wish my father could explain this to you because in Kansas during the depression their only currency was empty “milk bottles.” (By the way, what would the price of wheat be today, without the Soil Conservation and Domestic Allotment Act of 1936?) Your analysis of government spending and the multiplier effect is really quite insightful. Since it doesn’t really do anything it must truly be inconsequential. I agree with you on that premise. So the really issue is do you tax to pay for the services that you receive from our government or do you borrow the money? So the extended question is what services do you want from the government? So you really need to start making a list – get rid of the FDIC & SEC? I’d really like to keep these – in fact I’d really like to see the SEC do a better job. Some of the stocks that I hold were impacted by the financial crises, but I was able to get a real good price on another last May during the “Flash Crash.” Do we get rid of the FDA – I’d like to have them around to check for radiation in milk, make sure there’s no e-coli in our beef and no salmonella in our eggs. Do we cut back on our spending for the Department of Defense – don’t think I like that idea. Do you really want your Health Insurance provider practicing medicine? I like my doctor. Do you think that AIG could have paid off on all of the credit default swaps? So we borrowed lots of money to finance the Wars in Asia – maybe we shouldn’t have done that – The people that did that are a lot smarter than me.
    I’ve paid lots of taxes in my life and probably complained just about as much as anyone – but I’m more upset lately – because I just got through paying an additional hidden tax. You see we just spent over $600.00 on car repairs and two new tires when we hit a large chuck hole on a State highway a couple of weeks ago. An extra $50 bucks on our state tax last year and maybe I still have the other $550.
    I’d just like to say that I’d like to have the best government services at the least price. I’m trying to get some of that done – Sent an email to my congressman suggesting the congressional salaries by cut 40% which would only save about 30 million – but I don’t think we’re getting a good value from them. Maybe we should go with “pay for performance” like we do with teachers; then Michele Bachman = $0 others also.
    Thanks for letting me vent to your blog

    • Panos P. permalink
      April 19, 2011 9:01 am

      John as I read Kelly’s post I more or less outlined a respond identical to yours. Well put, sir.

      Kelly we met the other night and you asked me to read this. You are obviously a well educated economist but as John B. notes, these situations are not black and white and I’m sure you recognize that. We are of the most under taxed industrialized nations in the world. Even effective corporate taxes are much lower than the professing figures everyone quotes due the vast number of deductions available to most companies.

      I also believe we should have better government. Possibly less in some places but more in others such as the infrastructure example given.

      The problem lies in the you need some government but they are notoriously inefficient. I bet you’ve Freaconomics, of which the take-away point seemels to be pay attention to incentives. Incentives drive people whether monetary, social, sexual, etc. I believe the questions should be how can we simplify tax incentives to keep clarity in the markets and the business world and how can we adjust the incentives of politicians so that they once again work for the common good of the voters. These are the challenging problems of which I not qualified to solve alone – the rest are basic economics and will not be the path to solving our nation’s problems.

      • Panos P. permalink
        April 19, 2011 9:03 am

        Bah! Please excuse the typos – written on an iPhone in the passenger seat of a moving car🙂

  4. T C Rockett permalink
    December 10, 2011 9:09 am

    The genius of the founders of this country was 2 things. (1.) There final decisions were made with the Judeau-Christian definition of right and wrong as their guide. (2.) they wanted the people to control the government, not the other way around. We the people have allowed our government to grow too large and unethical. We the people produce plenty of goods and services worth plenty of money to support limited government and be the most financially stable country in the world, but we the people have chosen to give it away to thugs, crooks, and unwise power hungry polititians. It is imperative that we vote in new, honest, principled, statesmen who stand for a proper conviction, not those who are building a publicly desired model so they can be elected or re-elected. We all need to pay taxes, but but none should be hidden and they should all be approved by the people.

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