Monday, December 15, 2008

Just Say No To Keynesian Leaky Bucket Economics

In the video above, Cato Institute's Dan Mitchell explains why Keynesian economics sounds good but is fundamentally flawed, and why bigger government cannot stimulate the economy. Reason: Before government can inject money/spending into the economy, it first must take money out of the economy (borrow or tax), so the net result can never be anything more than an inefficient redistribution, shifting and transfer of income/spending from one group to another. Kind of like transferring water from Group A to Group B, but with a leaky bucket (see picture below).

As George Mason economist Russ Roberts said on NPR earlier this year:

When you just send out checks from the government (MP: implement a Keynesian stimulus), whoever gets stimulated is likely to be offset by someone who gets unstimulated. The money has to come from somewhere. If you raise taxes to fund the plan, the people who are taxed are poorer and they'll spend less. If you borrow money to fund the plan, the people who buy the government bonds have less money to spend and that offsets the stimulus. It's like taking a bucket of water from the deep end of a pool and dumping it into the shallow end. Funny thing—the water in the shallow end doesn't get any deeper.

That's why stimulus schemes based on giving people money have a poor track record of energizing the economy. Usually, the only thing that gets stimulated is a politician's approval rating.


At 12/15/2008 3:57 PM, Anonymous Anonymous said...

True enough.

What about stimulating things in order to counteract a real market failure?

Of course, determining waht a market failure is ssms mostly to be a political exercise.


At 12/15/2008 4:01 PM, Anonymous Anonymous said...

I agree with the point that a government stimilus is the government sucking money out of the private sector and pumping it somewhere else, but in the current situation it is appropriate.

The banks are unwilling to lend and they are falling over themselves to buy treasuries. The private sector demand is failing and only the government can act as the "buyer of last resort".

Even if the Keynesian bucket is leaky, it is at least guaranteed to be liquid unlike the frozen solid bucket that is the private sector today.

At 12/15/2008 4:33 PM, Blogger Ryan said...

However couldn't the same be said about a tax cut? That lowering peoples taxes mean that someone is going to have to go without government provided handouts?

Personally I favor the tax cutting option but couldn't the situation be implemented in the opposite way?

At 12/15/2008 5:12 PM, Blogger Free2Choose said...

"However couldn't the same be said about a tax cut?"

Good question, Ryan. I've remained a skeptic when it comes to the stimulus checks. But I have rationalized it by telling myself it was only the case of the government giving me back what was already rightfully mine.

I assume, however, that some recipients of stimulus will receive more than they actually contributed in taxes. This obviously means a case of more going out than comes in.

Also, tax cuts have a little more permanence. They tend to be viewed, more or less, as a real increase in income for the intermediate-long run. A stiumulus check is nothing more than a one-off shot in the arm.

At 12/15/2008 5:15 PM, Anonymous Anonymous said...

What if a government didn't finance the stimulus by extracting the money from others in the economy, but instead issued debt? And suppose the debt market for this particular government is so large that the effect on the interest rate of issuing another couple hundred billion is negligible, so you don't worry about crowding out private investment? Does that force Russ Roberts and Dan Mitchell to argue against the stimulus policy on different grounds?

At 12/15/2008 5:18 PM, Anonymous Anonymous said...

^^addendum to my above post:

I agree that the stimulus is feeble because we know individuals optimize over a longer time horizon than "today" so some/most of the stimulus is saved and it ends up being an inefficient/ineffective stabilization policy. I just wonder what is the next argument to bring against the stimulus once the Keynesians argue the "issued with debt" and "no crowding out effect" point I speak of above?

At 12/15/2008 5:28 PM, Anonymous Anonymous said...

I think we are talking about different things here. Yes, simply giving out tax rebates was not a proper way to stimulate the economy. Most of those rebate checks weren't spent anyway.

But the upcoming stimulus package that is being proposed is mostly geared towards spending by government on public works. This makes sense because private demand is retreating, there is no inflation risk and money can be raised easily and at low rates by the government.

At 12/15/2008 5:31 PM, Blogger juandos said...

"Even if the Keynesian bucket is leaky, it is at least guaranteed to be liquid unlike the frozen solid bucket that is the private sector today"...

Frozen?!?! For who?

Loans are being floated everyday locally for all sorts of reasons here in the St. Louis, Mo area?

A George Reisman article at Mies: Standing Keynesian GDP on Its Head: Saving Not Consumption as the Main Source of Spending

"The supporters of the stimulus package assume that all that is necessary to increase the demand for goods and services all up and down the line — that is, at all stages of production from retailing to wholesaling, through manufacturing, to mining and agriculture — is to increase the demand for consumers' goods, essentially by printing money and giving it to various consumers to spend. Yet if all that happened was that people spent the new and additional money in purchasing consumers' goods, there would not be any additional demand for capital goods and labor whatsoever based on that new and additional money."...

At 12/15/2008 5:38 PM, Blogger PeakTrader said...

The money comes from savers, i.e. investors, who buy U.S. Treasury bonds, including foreigners, and shifted to lower income people with higher marginal propensities to consume. So, demand is stimulated.

Bush proved cutting taxes in 2001 was effective. However, he failed to raise taxes when the recovery was underway (e.g. in 2005). The Bush tax cut earlier this year was also effective. Clinton raised taxes when the expansion was underway, but failed to cut taxes to prevent a recession (and stock market crash).

At 12/15/2008 6:20 PM, Blogger juandos said...

"However, he failed to raise taxes when the recovery was underway (e.g. in 2005)."...

What Bush failed to do was cut entitlements, the most costly and most Constitutionally questionable portion of federal spending...

From the IBD opinion section by Joseph Guinto: Is America The Land Of The Poor?

Since the Great Depression, more than $5 trillion has been spent fighting poverty at the federal level. Things have gotten better, but not much.
Since the War on Poverty, the share of the U.S. population defined as poor has dropped from 14.7% in 1966 to 12.7% in 1998. In 1959, when the government started tracking poverty, the number of people living below the poverty level was 40 million. In 1998, the number was 34.5 million

The Media's Top 10 Worst Economic Myths of 2008

Each year the Business & Media Institute looks back on the year's news and selects the top 10 worst economic myths. Here is our 2008 list:

10. Capitalism is dead or dying.

9. Gas at $4-a-gallon, blame the oil companies.

8. Fannie’s failure

7. Barack Obama sends stocks soaring, but not sinking.

6. Alternative energy: All gain, no pain

5. The economy has a fever and the only prescription is more bailouts.

4. Attack of the Killer Tomatoes

3. Oil prices will skyrocket to $200 a barrel, gas to $15.

2. Welcome to 1929: Great Depression II

1. America needs a new, New Deal.

At 12/15/2008 7:15 PM, Anonymous Anonymous said...

I'm against the bailout, but the critics of keynesianism miss a point: the taxes financing the stimulus will be paid by our children, not some «unseen» group in the economy right now. A stimulus can ease the pain for some people momentarily. See it as an insurance, with the premium to be paid later.

Of course that doesn't make a stimulus a good policy. On net, it's a loss, an unproductive use of money. But that doesn't mean it can't ease the pain for some. Yes there is a cost, but it is to be paid later, when hopefully the economy will be stronger.

That's why I find the Bastianian argument of the «unseen» group rather weak in this case.

At 12/15/2008 11:48 PM, Blogger Malachi said...

"the taxes financing the stimulus will be paid by our children, not some «unseen» group in the economy right now"
-- David

No David. The government is selling bonds, pulling money from one part of the economy to spend it in another.

There's a good supporting argument for doing that right now though not mentioned. Right now people around the world are literally giving their money to the Treasury for free (ie. zero percent interest rates).

Personally though, I think that money should be used to pay for a payroll tax holiday. Make labor cheaper to buy.

At 12/16/2008 12:17 AM, Anonymous Anonymous said...

Isn't it a mistake to keep assuming and asserting that every dollar not paid in taxes by the affluent automatically gets recycled (spent)into expanding the economy? I think PeakTrader may be making a good point in this regard.

Furthermore, in recent years, has not our nation's wealth gotten more and more concentrated in the hands of fewer and fewer? If so, therefore is not more of that waelth less efficiently circulated throughout the economy than if it had been in the hands of those who do not have the luxury of savings and equities?

At 12/16/2008 6:57 AM, Blogger Malachi said...

"Isn't it a mistake to keep assuming and asserting that every dollar not paid in taxes by the affluent automatically gets recycled (spent)into expanding the economy?"
-- Anonymous

What do they do with it then? Stick it under their bed?

"Furthermore, in recent years, has not our nation's wealth gotten more and more concentrated in the hands of fewer and fewer?"

First, the size of the pie is not fixed. It grows.

Second, the rich aren't the same people who occupied the group a few years ago. People move in an out of it. There's lots of economic mobility in this country.

At 12/16/2008 1:05 PM, Blogger Kevin Murphy said...

The problem with a "stimulus" package is what they are trying to accomplish. They aren't "stimulating" the economy, they are giving money to lots of people. The trouble the economy is having is that a lot of people have cut back on spending. And isn't because they are under stimulated, it's because they are over stimulated - over stimulated by worry that is: worried about their job, worried about their savings, worried about their house, worried that another decade long depression is around the corner, worried that everybody else is worried. People have cut back on spending not because they don't have the money, it's because they want to keep what money they do have. You give them cash now, and all they will do is save it.

What we need is an Alfred E. Neuman Package: what, me worry? And that's been the problem with TARP - Paulson came out and scared the bejeebers out of people describing in lurid detail how their way of life could come to a sudden and unhappy end at the precise time people were paying attention - i.e. the home stretch of the election - and when evidence that something was rotten right here in America with household names falling left and right and since then hasn't done a thing that stops, let alone slows, the end as far as we Joe ordinaries can see.

Thanks Hank, next time yell "Fire" in a crowded theater, it'll do less damage.

And the implicit claim that we'll be better off with the government either running everything or guaranteeing everything only makes things worse. Because if that's all we got, we've got less than nothing, we've got failure as far as the eye can see.

At 12/16/2008 4:55 PM, Blogger Marko said...

This thread is probably already dead, but I had to say this: Didn't Bush and the Republican'ts supposedly "destroy" the economy by spending too much? And now, the solution is to spend more? Come on - how stupid are we!

At 2/06/2009 11:43 AM, Blogger Unknown said...

Doesn't the first rule of holes apply here? If irrational spending and lending got us into this, how can irrational spending and lending (and borrowing) get us out?


Post a Comment

<< Home