Why in the World Are We All Keynesians Again? The Flimsy Case for Stimulus Spending

February 14, 2013 • Policy Analysis No. 721
By Andrew T. Young

The U.S. federal government responded to the financial crisis and recession that began in 2007-08 with unprecedented fiscal stimulus. Passed in February of 2009, the American Recovery and Reinvestment Act (ARRA) came with a price tag of $831 billion. Yet the economy has not returned to a path of robust economic growth and unemployment has stubbornly remained high; only in September of 2012 did it dip (barely) below 8 percent. This has not stopped the Obama administration from pushing for further fiscal stimulus.

Whether or not fiscal spending stimulus is effective hinges critically on the size of the spending multiplier, which is dependent on several factors. In particular, if individuals anticipate the future tax liabilities associated with deficit spending and/​or are “crowded out” by the deficit spending, then the multiplier is likely to be less than one; that is, each dollar of stimulus increases total spending in the economy by less than one dollar. Ultimately, whether the government spending multiplier is less than or greater than one is an empirical question.

While no one seriously debates the long‐​run costs associated with exploding public debt, the evidence suggesting significant short‐​run benefits of stimulus spending is weak. Studies suggesting that stimulus spending is effective assume that current economic activity does not affect fiscal policy. This assumption is questionable and, most important, the studies’ results are very sensitive to it.

Alternatively, studies using a narrative approach based on historical and contemporary accounts of U.S. military buildups to identify government spending shocks find that the short‐​run effects of stimulus spending are small. These latter studies are grounded in historical reality and are thus more compelling.

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About the Author
Andrew T. Young is an associate professor of economics at West Virginia University and the College's BB&T Scholar. His papers have been published in Public Choice; Journal of Money, Credit and Banking; Review of Economics and Statistics; Managerial and Decision Economics; Review of Economic Dynamics; and Review of Austrian Economics.