Eighteen months after President Barack Obama administered a massive dose of spending increases and tax cuts to a weak economy, a brawl has broken out among economists and politicians about whether fiscal-stimulus medicine is curing the illness or making it worse...One side says Mr. Obama's $862 billion fiscal stimulus prevented an even graver recession. Cutting the deficit right now, this side insists, would send the economy into a tailspin. The other side questions the benefits of the stimulus and argues addressing long-term deficits now is crucial to avoid higher interest rates and even bigger economic problems down the road.
And then there is a camp in the middle—defending last year's stimulus, but urging a deficit-cutting plan now...
"Too many are searching for answers in the discredited economic playbook of borrow-and-spend Keynesian policies," Rep. Paul Ryan, a Wisconsin Republican who is pushing a long-run deficit cutting plan, said this month. "I reject the false premise that only forceful and sustained government intervention in the economy can secure this country's renewed prosperity."...
Richard Trumka, president of the AFL-CIO union alliance, says if the government starts cutting deficits now, "We'll slip back into recession and possibly depression."...
But today, neither side can say with certainty whether the latest stimulus worked, because nobody knows what would have happened in its absence.
Fed Chairman Ben Bernanke backed fiscal stimulus in early 2009. Now he says the economy still needs fiscal stimulus, but says it must be accompanied with a credible plan to reduce future deficits. Like the Obama administration, he doesn't think that plan should be implemented until the economy is on more solid footing...
The case that government deficit spending can be vital at times of recessions dates to John Maynard Keynes, the British economist whose teachings dominated economics for decades after the Great Depression. "Pyramid-building, earthquakes, even wars may serve to increase wealth," Mr. Keynes said in his 1936 classic, "The General Theory of Employment, Interest and Money."
A counter-revolution led by Milton Friedman, of the University of Chicago, de-emphasized the role of government and gave rise to Ronald Reagan and Britain's Margaret Thatcher. Keynes lost favor during the stagflation of the late 1970s and early 1980s. The Fed and its manipulation of interest rates came to be seen as the best way for governments to manage the short-term ups and downs of the economy...
The Obama administration is stocked with heirs of Mr. Keynes, including academics Christina Romer and Mr. Summers. Ms. Romer famously projected in January 2009 that without government support, the unemployment rate would reach 9%, but with support the government could keep it under 8%. It's 9.5% today...
Underlying the debate is a long-running argument about how much of a lift the government gets from spending more or taxing less. Keynesians argue that when the economy is distressed, a dollar spent by the government multiplies in value. It gives a worker income the private sector has failed to produce, which he spends, creating demand for goods and services.
Ms. Romer argued last year that this "multiplier" for government meant every dollar spent created about $1.50 worth of demand...
Robert Barro, a Harvard economist, found even smaller multipliers: A government dollar spent creates about 80 cents worth of growth, or possibly less, he says. Government spending, he says, crowds out private sector spending that would otherwise be taking place...
Carmen Reinhart, a University of Maryland economist who has studied the fiscal aftermath of financial crises, says more stimulus could be counterproductive because it could lead the public to expect even higher taxes in the future...
"We are not in an easy position," she says. "Credibility is going to be difficult to achieve."
My thoughts: Central planning does not work. It does not matter if the method of central planning is fiscal policy or monetary policy. Politicians do not understand how economies work.
A recession is better understood as a "market correction". When a cluster of errors occurs from artificially low interest rates, this generates an unsustainable boom. Once the boom occurs the bust is inevitable. The Fed created the boom. Ben Bernanke will eventually be known as the worst Fed chairman ever. The Creature from Jekyll Island hopefully will die a quicker death due to the incompetence of Bernanke.
Keynesian economics never truly died, it was merely displaced by the monetarist economics of Milton Friedman and the Chicago School. Mainstream economic thought came to believe that monetary policy was most effective and that Keynesian solutions should be reserved for when monetray policy could not produce the desired effects.
Both Keynesians and monetarists do not truly understand how economies work. For the Keynesians, you can't spend yourself into prosperity. Pyramid-building, earthquakes, and wars are the solution to economic problems. Pyramid-building (also known as public works) is an unnecessary function of government that only serves to put the nation into deeper debt. Earthquakes and wars kill people and destroy capital, which is the opposite of what is needed for economic growth. For the monetarist, attempting to paper over a bubble that was originally created by easy money policy is insane. You don't solve problems by doing the same thing that caused the problem to begin with.
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