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WSJ.com- Opinion: Why Spending Stimulus Plans Fail

Congressional Democrats are now demanding another economic stimulus package to “inject” as much as $300 billion into the economy. The package will fail–


just like last year’s $333 billion in emergency spending and $150 billion in tax rebates failed.

No it didn’t. Q2 was well over 2% due to the rebates.

There’s a simple reason why.

Government stimulus bills are based on the idea that feeding new money into the economy will increase demand, and thus production.

Which it does.

But where does government get this money? Congress doesn’t have its own stash. Every dollar it injects into the economy must first be taxed or borrowed out of the economy.

The funds the government borrows are the ‘same’ funds the government deficit spends.

No new spending power is created. It’s merely redistributed from one group of people to another.

Wrong, government borrowing does not remove net nominal wealth. All it does is offer treasury securities as alternatives to reserve balances.

Taxing, however, does remove net nominal wealth. Paying taxes lowers reserve balances.

Of course, advocates of stimulus respond that redistributing money from “savers” to “spenders” will lead to additional spending.

No, to that point, giving net new balances to consumers tends to increase spending. Nothing is taken away from savers by deficit spending. In fact, deficit spending increases savings by the same amount.

That assumes that savers store spare cash in their mattresses, thereby removing it from the economy. In reality, nearly all Americans either invest their savings (where it finances business investment) or deposit it in banks (which quickly lend it to others to spend).

No, that’s reverse causation. In fact, the causation goes from loan to deposits. Bank deposits are the result of bank loans. They are not ‘used up’ by lending.

The money gets spent whether it is initially consumed or saved.

It’s not a question of ‘the money.’ Income is either spent or not spent. And borrowing to spend is not constrained by available savings to lend.

Governments don’t create new purchasing power out of thin air.

Yes they do. In fact, that’s the only place it can come from.

If Congress funds new spending with taxes, it is redistributing existing income.

Sort of. But spending isn’t ‘funded’ as it’s merely a matter of government crediting a bank account. It’s just an entry on a spread sheet. Entries don’t ‘come from’ anywhere.

Taxes are also a spread sheet entry- in this case the reduction of someone’s bank balance. But nothing ‘goes’ anywhere- data just changes.

If the money is borrowed from American investors, those investors will have that much less to invest or to spend in the private economy.

No, borrowing to spend from investors moves the balances from the investors account to the account of the recipient of the spending.

If the money is borrowed from foreigners, the balance of payments must still balance. That means reducing net exports through exchange-rate adjustments, thereby leaving net spending on the economy unchanged.

Not at all. Foreigners receive funds from net exporting to the US. They then exchange these bank balances for other financial assets, such as treasury securities. The exchange of one financial asset for another has nothing to do with the balance of payments or trade.

Yet Congress will soon borrow $300 billion from one group of people and then give it to another group of people and tell us we’re all wealthier for it.

Nominal wealth of the non government sectors does go up by 300 billion. Real wealth is another story.

Lawmakers commit this fallacy repeatedly. They tout unemployment and food-stamp spending as stimulus without asking where the programs’ funding comes from. They hype a federal bailout of the states as stimulus, as if having Congress do the taxing and borrowing instead of state governments makes it a free lunch.

Wrong, and the media commits this fallacy repeatedly.

And, especially in this era, when “our crumbling infrastructure” seems to have become the new mantra, legislators and lobbyists tout a 2002 Department of Transportation (DOT) study that they believe proves that every $1 billion spent on highways adds 47,576 new jobs to the economy.

At the macro level, they should say this ‘costs’ 47,576 jobs as work is a cost, not a benefit. The benefit is the output from the work.

The problem is that the study doesn’t actually make that claim. It stated that spending $1 billion on highways would require 47,576 workers (or more precisely, would require 26,524 workers, who then spend their income elsewhere, supporting an additional 21,052 workers).

The fewer workers it takes to get the job done the better for all of us, provided government knows how to sustain demand at full employment levels.

But before the government can spend $1 billion hiring road builders and purchasing asphalt, it must first tax or borrow $1 billion from other sectors of the economy, which then lose a similar number of jobs.

No it doesn’t. The billion is net spending. And the billion it spends are the same funds that it ‘borrows’.

In other words, highway spending merely transfers jobs and income from one part of the economy to another.

Not if it employs unemployed resources.

As economist Ronald Utt has explained, “The only way that $1 billion of new highway spending can create 47,576 new jobs is if the $1 billion appears out of nowhere as if it were manna from heaven.”

Another economist who doesn’t understand how a spreadsheet works.

The DOT tried to correct this misperception in an April 2008 memo specifying that their analysis refers to “jobs supported by highway investments, not jobs created” (italics in the original). The Government Accountability Office and Congressional Research Service also released studies making the same point.

Of course, they have no idea if the people will come from other employment or be the employment of idle resources. And if the economy is already at full employment that’s how many jobs there are.

In reality, economic growth — the act of producing more goods and services — can be accomplished only by making American workers more productive.

Or putting the unemployed to work.

Productivity growth requires a motivated and educated workforce, sufficient levels of capital equipment and technology, a solid infrastructure, and a legal system and rule of law sufficient to enforce contracts.

The best measure of a policy’s impact on economic growth is through productivity rates. Lower marginal tax rates encourage working, saving and investment, all of which increase productivity (as opposed to tax rebates, which are grants that require no additional productive efforts).

Even Laffer would not agree. As he says, his curve works at the extreme- 100% tax- but it’s been impossible to detect much difference in the middle ranges.

Reforming — rather than merely throwing money at — education and infrastructure will raise future productivity. These necessary improvements would take time and shouldn’t be considered short-term “stimulus.”

All good, but doesn’t alter the shortage of aggregate demand that only fiscal policy can address.

It’s time for lawmakers to stop futilely trying to wave the magic wand of short-term “stimulus” spending, which threatens to push the deficit above $1 trillion.

It’s time for the Wall Street Journal to wise up and stop publishing this stuff!

Focusing on productivity will build a stronger economy over the long run and leave America better prepared to handle future economic downturns.



15 Responses

  1. (Sorry about posting this one twice–this is where it goes.) FYI, I tried to post this to the WSJ discussion of the Op-ed, but it wasn’t accepted. Written quickly, so not perfect, but gets at some of the same criticisms.

    Mr. Riedl’s article demonstrates an all-too common lack of understanding of the operational functioning of our flexible exchange rate monetary system, as do the overwhelming majority of the comments here.

    One of the above commentators did note, however, that an option available to the Treasury is to print money. The reality is, however, that the Treasury creates “money” WHENEVER it deficit spends, whether or not it sells bonds. Modern governments spend by crediting bank accounts; tax payments result in the debiting of the same accounts. A deficit is simply the crediting of more balances to these accounts than is debited; this necessarily raises the net financial assets of the non-government sector. A bond sale, on the other hand, has no effect on net financial balances of the non-government sector, as it is simply a trade of a non-interest bearing asset for an interest bearing one. The net result of both transactions, then is that a deficit by definition results in a net increase in the financial balances of the non-government sector even when bonds are sold—this is a fundamental truth of national income accounting that is true by definition. It is only under a commodity money (like a gold standard) or a currency board (as in Hong Kong) monetary system that a deficit results in an outcome that resembles the “loanable funds” and “crowding out” paradigm Mr. Riedl refers to throughout his article.

    Furthermore, consider how an actual purchase of a government bond occurs in our system. An individual desiring to purchase the bond will have balances debited from his/her bank account, while this individual’s bank (or the bank’s clearing bank) will actually carry out the purchase of the bond from its reserve account, since Treasury bonds can only settle via these accounts. But reserves used to buy these bonds are themselves placed into circulation when the Fed buys Treasury bonds that resulted from previous government deficits. In fact, shortly before Treasury auctions settle, it is well-known that the Fed engages in open market operations to provide the reserves to the financial system required for settlement of the auction. That is, the “money” used to buy bonds comes from deficit spending—or, otherwise stated, it is the deficit spending that necessarily comes first, before the bond sale. In our system, then, bonds do not finance government deficits; rather, government deficits PRECEDE bond sales.

    It is the sort of analysis provided by Mr. Riedl that is at the root of the current lack of sufficient aggregate demand in our economy, and it is the same sort of thinking that will keep us from emerging from this downturn anytime soon.

  2. Nice. The only thing I would change is to delete the word “deficit” before spending. In other words: “The Treasury creates “money” WHENEVER it spends” i.e., the creation of new money is the mechanism by which the feds finance themselves. A deficit or surplus is an after-the-fact accounting balance. The mechanism itself is “spend to create money, tax to destroy it, “borrow” to support nonzero interest rates” By concentrating on the deficit, you (IMO) cloud your main point.

    Not that it matters – your average WSJ reader is not going to understand it in any case. I was just reading an excerpt from Malcom Gladwell’s new book in which his main thesis is that it takes 10,000 hours of practice to become an expert on a given topic. I’m begining to be afraid that that’s how much time it takes to unlearn conventional economics…

  3. Jim . . . completely agree. Was trying to keep it short (not that it mattered, since it didn’t make the cut), but your version is both more precise and more efficiently worded.

  4. If you stand back and look at the big picture, it looks like they are putting off the inevitable. They throw a patch at the system every once and a while but they never have any plan other than prolong the mess for someone else? Or do they know something?!

    I have been around the block a few times in the last 20 years or so doing work for Harley Davidson, Parts Unlimited, ABC Supply, Chevy, Ford and many others. The American worker has painted them selves into a corner with Unions and a lazy work ethic. Meanwhile the government has tossed them to the cleaners with NAFTA and others. They told everybody that social security was not going to be there for them and they needed a 401K, throwing a pile of cash at Wall Street to plunder. Look at everybody’s retirement account now!

    I do not see hope for anything positive in the future for the US, the rest of the world looks at us like thugs and warmongers. Our government is accused of high treason in the 911 attacks and the corporate media makes it so obvious with the blind eye to the subject.

    America has eaten its self, you know what comes next!!! POOO


    Warren have you seen this yet? Believe it or not, it is entertaining!

  5. Tomorrow I will have as a guest on my radio show, Brian Riedl, the guy from the Heritage Institute who wrote that op-ed piece in the WSJ (“Why Spending Stimulus Plans Fail”). You can listen LIVE by tuning in at 10:20am Eastern Time at http://www.bizradio.com (click on “Listen Live” link).

    You can call in toll free with questions (877) 777-7713 or send me an instant message at MSN Messenger (contrarianmedia@hotmail.com)

  6. Thanks Mike, I’ll be listening. This should be entertaining. Be gentle.

    You should have Warren or Scott on too. Or as a follow up.

    Far too few people have any clue that fed govt spending != personal spending.

  7. Also, what was he talking about with a treasury holding not counting as part of GDP but a cash deposit counting as part of GDP. How can a well respected institution like the wall street journal allow content from people that do not understand the fundamentals.

  8. He posts pod-casts of all his shows. It didn’t go very well, Mike tried to lead him into a mouse-trap, but the trail to the trap was too long and then they ran out of time and the guy hung-up. IMHO, it would be better to just make a thesis statement and then argue off of that.

  9. Yes, it was a terrible interview. I am not doing that anymore, with these people who are so dogmatic.

    It will be on the podcast archives later or tomorrow.

    For me, the biggest thing was when he said that the $600 billion in reserves that just appeared over the past few months came from new deposits (implying $6 trillion or more of new deposits out of nowhere).

    He finally said that he didn’t know where the reserves came from. When I said that they are credits to the system that the Fed makes, he said, “Oh, you’re talking about the Fed and monetary policy, I’m talking about what Congress does.”

    It’s all the same thing.

  10. Mike I think it was a great idea. These people should be called out and spanked relentlessly. It is hard to argue with people who are uninformed about opaque abstract concepts like reserve accounting. Next time I am sure it will go over better.

  11. Interview’s posted now.

    Riedl’s an absolute joke . . .

    Doesn’t understand that the Treasury’s account is a liability on the Fed’s balance sheet.

    Doesn’t understand that in order to purchase a Tsy, the purchaser’s clearing bank must use its reserve account.

    Doesn’t understand that loans create deposits.

    Doesn’t understand that the purchaser of a Tsy has not reduced his/her purchasing power–apparently he’s never heard of the repo markets. (Again, loans create deposits.)

    Doesn’t understand probably a million more things, but I’ll stop there.

    Kudos to Mike for using his show to take this stuff on when nobody else in the media has a clue.

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