Debunking a “theoretical” criticism of the Obama Stimulus

January 26, 2009 · Posted in Big Business Ripoffs, Finance, Financial Crisis, Government, Political Figures, Political Issues, Politics, Thoughts on the economy · Comment 
January 20, 2009 - President Barack Obama Oath of Office

January 20, 2009 - President Barack Obama Oath of Office

OK, I am probably diving in over my head on this one.  So here goes.  The Wall Street Journal online ran an opinion piece (http://online.wsj.com/article/SB123292987008414041.html?mod=googlenews_wsj) which cites a study that claims to de-bunk the theory behind a Keynesian-style stimulus plan as a cure (partial or otherwise) for an ailing economy.

The basis of the argument is that when a government spends a dollar, it takes a dollar from some other pocket which washes the impact of the spending.

The claim is that because the government would have to (in this case) sell a bond, the investor that buys the bond would otherwise have invested the money somewhere that would have had much the same effect as the stimulus package would have on the greater economy.

I accept that this may be true in an otherwise healthy economy.  But in the current economy it must be kept in mind that the propensity of savers to invest in riskier assets – let alone in job creating businesses is sharply lower than what it would be in an otherwise healthy economy.  Thus it is likely that those funds, if not used to purchase the government bond used to finance the stimulus, would have stayed in some ultra secure savings vehicle, a bank account (and we know how eager banks are to lend these days) or some other asset which is ultra secure and would not in fact be deployed somewhere that would get the economy moving.

It is exactly in situations like the one we are in where a Keynesian stimulus package will work.  No, it will not cure all the economy’s problems.  Will it make them less severe than they otherwise might be.  I truly believe it will.

You can find a PhD or study to say just about anything you want.  The key is to understand the assumptions underlying the theory or study.  I have not reviewed the study referenced in the opinion piece.  But you do not need a PhD to know that Keynesian stimulus proposals – whose impact may very well be muted by less private spending in a healthy economy – are made to order for an environment where the propensity of consumers and investors is to be risk averse to an extreme degree.

Further, the psychological shift in confidence that may result in increasing private economy risk appetites (and is probably impossible to quantify in an economic study) over time from the knowledge that the government is stepping up to the plate is a key component in the effectiveness of any stimulus plan.

The article makes some good points about the first version of the stimulus package and its apparent lack of timeliness (when the money will be spent).  But this Congress and Administration have been in place less than a week (together).  Let’s give them a few weeks.

In ordinary times I am very much opposed to Keynesian policy for reasons consistent with the position laid out in the article.  But, like the great man himself once said, “when the facts change, I change my mind….what do you do sir?”

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