Stimulus: Kindergarten Keynesianism

It is very curious that some top economists are pushing the Bush/Pelosi $100 billion stimulus giveaway.

  • For years, these same economists told us that more savings is good for the economy. Now they are saying that more consumption is good.
  • For years, these same economists have lambasted the budget deficit. Now, they support blowing a new $100 billion hole in the federal budget.
  • Finally, many economists have long complained that Americans are shopoholics and have far too much credit card debt. Now stimulus-supporting economists are demanding that Americans spend, spend, spend!

It is surprising that anyone takes economists seriously anymore.

Anyway, stimulus proponents say that mailing $100 billion of cash to families will cause the nation’s output to grow. Yet this simple Keynesian chart illustrates that the result will be higher prices, not more output.

The stimulus causes the aggregate demand curve to shift to the right, as proponents suggest. That moves us along the aggregate supply curve, which I believe should be drawn vertically in this case. The result is that prices jump up from P1 to P2, but output does not rise.

Stimulus proponents would argue that the aggregate supply curve should be sloped, at least in the short run. In that case, the figure would show a temporary bump upwards in output.

But that seems unlikely to me. Keynesian theories about why output might increase usually rely on imperfections in markets or information. Producers get fooled into increasing their output for a while, before the errors are worked out and output falls back to its long-term level.

But that wouldn’t seem to be the case here. Let’s say the rebate checks get mailed out in May and June. A U.S. cigarette producer may notice a slight uptick in sales in those months as smokers spend their government checks. But cigarette producers probably watch the news and they will know that this is just a temporary blip. As such, they won’t add any new workers or buy any new machines.

So output would stay pretty fixed, while prices would adjust upward slightly to clear markets. But I don’t claim to be a Keynesian expert, so if one of our Keynesian readers wants to tell me where I’m wrong, I’d be happy to hear it. Until then, I remain convinced that the Bush/Pelosi scheme is crack-pot.