Why Keynesian Stimulus Doesn’t Work

This should be obvious.  Keynesian stimulus doesn’t work. In 2008 the government had two choices as to what actions it could take.  1. Cut taxes and regulation and otherwise do nothing. 2. Spend a buttload of money.  We all know what the choice was.  And what happened.

shoveling water

I think that  this gif explains it perfectly.  Only the government shoveled hundreds of billions of borrowed money.  With results that resembled about the same as shoveling water.

The problem was that the government wasn’t just shoveling water.  It was spilling out the stored wealth and energy of millions of Americans.  Even worse was that some of the stored energy was that of Americans who are too young to have created anything that adds to the economy or for that matter, note even born yet.

I’m the kind of guy who thinks that when you consider policies and ideas that no matter how sophisticated and ideological an idea is you have to consider the person who came up with it.  Bad ideas tend to reflect the character of their creators.  Thus knowing something of the person tells you a lot about the quality of their ideas.  Which is especially important when those ideas are turned into policies that affect millions of people.

In John Maynard Keynes’ case, how he experienced money and dealt with it for his lifetime is important when he wrote the theory of money that guides so much of the policies that government uses to try to “manage” the economy.  Especially when those policies produce such consistently disastrous results over and over.

Is the fact that Keynes was a gay man who lived a more or less hedonist lifestyle and had no children, important? Well, let’s look at it this way.  He was a man that never had to earn a living as consequence of having to actually work, had no real responsibilities for most of his life and had no children or expected to have any. He never had to care about where the money came from, if he was like most of the trust fund set he was more or less a spendthrift living check to check and without wife and kids had no real stake in the future.    This was the man responsible for the guiding of monetary policy for most of a century?

Keynes never had to live with the consequences of the policies we advocated, but we do.  I don’t know how many times I have seen the analogy of compairng a household budget to Keynseian policies and showing what a disaster they are.  One would think that Keynes would have had to deal with those problems and that that would be factor in formulating his theories.  But Keynes came from the intellectual neardowell side of the Bertie Wooster set.  He never had to worry about money because it was always there from the trust fund or his parents or whatever.  How can you understand work if you never HAVE to?  How can you understand enterprise if you are never involved in business?   I think these things are very important.  Probably the most important thing is the sterility of his life and the consequential sterility of the nation states following his theories.  Haven’t people noticed that there has been something really wrong?  Even during the Eighties I had this sense that things weren’t quite right and it’s pretty obvious that there’s a good chance that Progressivism is the reason.  There’s also the fact that so many of the advocates of Progressivism seem to be bent one way or another.  I don’t think that’s an accident.

Professor Niall Ferguson pointed this out and was ripped up by the typical SJW/gay activist types.  But he was correct to make the comment and he was right.  The problem with treating money as an abstraction is that money doesn’t just represent flows, animal spirits, supply and demand, it represents the work and returns on investment for everybody.  If you remove work, energy and investment from the equations there’s no way to really understand what’s going on.



As Mark Steyn points out


Well you can say that Keynes’ lifestyle had no impact on how he constructed his theory.  Really?  Could you say the same about Karl Marx? Or for that matter the Unabomber?   I know, the Unabomber was nuts. Think about that. Let’s look at some of how things worked before Keynes and what he said.

During the Napoleonic wars of the early nineteenth century, many European countries experienced serious inflations as governments resorted to the money printing press to fund their war expenditures. The lesson the free market economists learned was that the hand of the government had to be removed from the handle of that printing press if monetary stability was to be maintained.

The best way of doing this was to link a nation’s currency to a commodity like gold, require banks to redeem their notes for gold on demand at a fixed rate of exchange, and limit any increases in the amount of bank notes in circulation to additional deposits of gold left in the banks by their depositors. They also concluded that deficit spending was a dangerous means of funding government programs. It enabled governments to create the illusion that they could spend without imposing a cost on society in the form of higher taxes; they could borrow and spend today, and defer the tax cost until some tomorrow when the loans would have to be repaid. These free market economists called for annually balanced budgets, enabling the electorate to see more clearly the cost of government spending. If a national emergency, such as a war, were to force the government to borrow, then when the crisis passed, the government should run budget surpluses to pay off the debt.

Keynes’ Thinking on Markets, Wages and Government

These were considered the tried and true policies for a healthy society. And these were the policies that Keynes did his best to try to overthrow in the pages of his book, The General Theory. He argued that a market economy was inherently unstable, open to swings of irrational investor optimism and pessimism, which resulted in unpredictable and wide fluctuations in output, employment, and prices. Only government, he believed, could take the long view and rationally keep the economy on an even keel by running deficits to stimulate the economy during depressions and surpluses to rein it in during inflationary booms.

He therefore attacked the notion of annual balanced budgets; instead, government should balance its budget over the “business cycle,” that is, deficits during recessions and surpluses during full employment and economic growth years. But to do this job, Keynes said, the “barbarous relic” of the gold standard should not hamstring governments. Wise politicians, guided by brilliant economists like himself, had to have the flexibility to increase the money supply, manipulate interest rates, and change the foreign-exchange rates at which currencies traded for each other. They required this power so they could generate any amount of spending needed to put people to work through public-works projects and government-stimulated private investments. Limiting increases in the money supply to the quantity of gold would only get in the way, Keynes insisted.

Keynes believed not only that the market economy could not keep itself on an even keel he also believed that it would be undesirable to allow the market to work. He once said that to have the market determine prices and wages to balance supply and demand was to submit society to a cruel and unjust “economic juggernaut.” Instead, he wanted wages and prices to be politically fixed on the basis of “what is ‘fair’ and ‘reasonable’ as between the [social] classes.”

During the Great Depression years of mass unemployment, he argued that the level of wages imposed by trade unions were to be viewed as sacrosanct, even if many workers were priced out of the market because the level was higher than potential employers thought those workers were worth. The government, instead, was to print money, run deficits, and push up prices to any level needed to make it again profitable for employers to hire workers. In other words, perpetual price inflation was to be the means to assure “full employment” in the face of aggressive trade unions demanding excessive wages.

The “Austrian” Alternative to Keynesian Economics

What Keynes completely discounted and, in fact, rejected was the alternative “Austrian” interpretation of the causes and cures for the Great Depression, as formulated by Ludwig von Mises, Friedrich A. Hayek and others. For the Austrian Economists, monetary expansion and interest rate manipulation had set in motion serious and distorting imbalances between savings and investment that resulted in mal-investment of capital, and misdirection of resources and labor – even though this happened in the United States under the seeming non-inflationary circumstances of a relatively stable price level.

Keynes’s new “macroeconomics” of focusing primarily on economy-wide statistical averages and aggregates – such as “aggregate demand,” “aggregate supply,” output and employment “as a whole” – hide from view all the real “microeconomic” relationships and interconnections between numerous individual supplies and demands that were being thrown out of coordination and balance due to the monetary policies of central banks.

When the financial and economic crisis of 1929-1930 began to snowball into wider and wider circles of falling output and rising unemployment, the Austrians had emphasized that a rebalancing throughout many parts of the economy required price and wage adjustments, and labor, capital and resource reallocations to restore coordination between those interconnected supplies and demands. But this was the explanation and solution to the Great Depression that John Maynard Keynes rejected and refused to understand. – See more at: http://www.epictimes.com/richardebeling/2016/02/the-follies-and-fallacies-of-keynesian-economics/#sthash.Ymu7Jt5A.dpuf

The problem with Keynes spend now and pay later theory is that the perverse incentives to spend ever increasing sums, the moral hazards of all the “free money” and the lack of restraint on the part of politicians take the pay it back part out of the equation.  One thing that the last eighty years has taught us all is that saying “no” is rather impossible for politicians.  It doesn’t help that most of the politicians come from the same sort of background that spawned Keynes.

The problem is that with our party hard graduates of the Ivy covered Snob Factories that constitute most of the leadership of this country is that they don’t seem to understand that the time comes when the party’s over and that the credit card has a spending limit for a reason.  Giving people like this the  unlimited ability to up the credit limit on the national credit card does not end well.

Armstrong Williams makes a strong case as to why constantly increasing the debt limit is not a good thing:

First, stimulus spending creates jobs.False. Stimulus spending financed by taxes substitutes relatively inefficient government spending for private spending. In other words, government spending “crowds out” private spending. The opposition may disagree that public spending is less efficient, but the recent analysis of the government spending does not support their point of view.

Second, many will tell you that it is not taxation, but debt that is financing the government spending; thus it is not crowding out private spending. I maintain that government debt crowds out private borrowing and investment. Many of my anti-capitalist colleagues say that government spending is not crowding out private investment because interest rates are low. Therefore there is plenty of money to finance private investment. Unfortunately, in an attempt to protect depositors, and the government guarantee of such deposits, the bank regulators have increased the credit-underwriting requirements on banks. Consequently, banks are not lending to small- and medium-sized businesses.

The business community realizes that the increased money supply is financing government spending, and the private sector must eventually pay the piper. Consequently, the business community is not investing as much as it might because it is concerned about inflation and higher future taxes to pay for the borrowing. Since business investment takes time to earn a return, the businessman making an investment now expecting a return two or three years from now knows that his taxes are going to be increased with the expiration of the Bush tax cuts and the 3.8 percent new Obamacare tax on unearned earnings. Thus the businessman is not investing today because he knows his return is being significantly reduced two years from now.

Third, the argument of skyrocketing business investment is based on historically low investment in 2009 created by the worst recession since the Great Depression. Investors in 2011 are merely “catching up.” Investment is not above the trend line.

Fourth, the left’s idea to stimulate the economy through a tax credit for firms that increase employment shows a fundamental lack of understanding of why companies increase employment. Jobs are a byproduct of increased sales and revenues. Companies do not like to hire employees. They are expensive, require management and cannot be easily laid off in cases of incompetence or the loss of business.

Companies increase employment because they have additional business that needs to be processed, and they cannot process it through overtime or increased capital. No businessman in his right mind would hire someone merely because labor is 10 percent cheaper because of tax credits. He would only increase employment if that is his only alternative to process additional business. If he has additional business, then he will hire additional employees, regardless of the 10 percent credit. Therefore, the credit is an inefficient way to increase employment and a waste of taxpayer money.

Fifth, the plan for serious budget reduction in the future does not work without a big initial down payment in spending cuts. Today’s Congress cannot bind future Congresses, and Congress has been notoriously unreliable with respect to the fiscal management of the country’s finances. Only a naive observer of the political environment in America today could believe that lawmakers will constrain spending to bring the deficit under control when the economy improves.




The problem with stimulus is that between the waste and the cronyism it creates enormous distortions in the economy.  The effect of Keynesian stimulus is to drain what energy there is in the economy and put it down the drain.  This at a time when economic energy is desperately needed. What Keynes and his followers don’t seem to understand is that money flows for reasons, to actually return value, make something, or pay for a service. Without reasons the money will not actually do anything at all.

The amazing thing is how powerful the belief in the Keynesian magic is.  One would think that all the past failures would tell all those smart people that doing things like this only represents a huge hangover after the party is over.  Yet from Japan in the 1980’s to China now, the people in charge keep making the same mistake.


And shoveling the  same water.  The abandoned newly finished cities in China are legendary.  And they do fill up, eventually.  That is if they don’t fall down first.

What Is the Future of China’s Ghost Cities?

The idea behind them is flawed, and in the end doomed to failure.  These cities are all enormous Ponzi schemes where the ball has to keep rolling or the governments go broke.  Sooner or later they are going to go broke and those enormous sums spent building all that stuff will have been just wasted.  That is if the local government doesn’t just break a bunch of windows or demolish a brand new building.


Of course China’s Central banks and local governments aren’t alone in their silliness.  Everybody wants to party.  Party very hard.  Maybe it’s because the leaders of the the various governments and central banks all believe that none of this will have any impact on their lives, or they all believe in pixy dust, but there’s a lot of just plain crazy stuff coming out of our glorious leadership these days.

Wow. I guess the moral of the story is that we should destroy lots of wealth because it’s good for prosperity. Just like we should eat more cheeseburgers to lose weight.

So you can see why I’m frustrated. It seems that evidence and logic don’t matter in this debate.

But maybe this latest example of Keynesian malpractice will finally open some eyes. The International Monetary Fund recently published a study asserting that higher spending on refugees would be good for European economies.

I’m not joking. Here are some excerpts from that report.

In the short term, the macroeconomic effect from the refugee surge is likely to be a modest increase in GDP growth, reflecting the fiscal expansion associated with support to the asylum seekers… In the short term, additional public spending for the provision of first reception and support services to asylum seekers, such as housing, food, health and education, will increase aggregate demand. …Relative to the baseline, the level of GDP is lifted by about 0.05, 0.09, and 0.13 percent for 2015, 2016, and 2017, respectively (solid line in the chart below, representing the response of EU GDP as a whole). For the first year, the output impact is entirely due to the aggregate demand impact of the additional fiscal spending.

To understand the implications of what the IMF is claiming, let’s review some basic facts, all of which presumably are uncontroversial.

First, we know that economic output is the result of capital and labor being mixed together to produce goods and services.

Second, we know that growth occurs when the amount of output increases, which implies increases in the quantity and/or quality of labor and capital.

Third, we know that the influx of migrants to Europe will lead governments to divert additional resources from the private sector to finance various programs.

Now let’s think about the IMF’s assertion. The bureaucrats are basically arguing that letting governments take a bigger slice of the pie somehow is going to increase the size of the pie.

If you’re wondering how this makes sense, welcome to the club.

The only way this analysis possibly could be true is if governments finance the additional spending by borrowing from foreigners. But even that’s not really right because all that’s increasing is domestic consumption, not domestic output.

In other words, it’s like running up your credit card to live beyond your means when the real goal should be increasing your income.


We need to rethink how we envision, create, and enact economic policy.  The people at the top need to realize that what they are looking at isn’t just charts and numbers, but real people doing real stuff.  We need economics that takes those people and their creativity and drive into consideration and promulgates policies that magnify the creative energy of the economy rather than suppressing it. We need economics as if humans were in the driver’s seat, not “animal spirits” that nobody has ever seen.



We need to realize that welfare schemes and top down central planning have fundamental flaws.  That robbing Peter to pay Paul an income hurts Peter and cripples Paul.  To say nothing of the impact to the rest of a society that bases it’s existence on rents and robbery rather than liberty and the rule of law.

 The status quo “solution” to the decline of opportunities for meaningful work is predictably top-down: guaranteed income for all, a.k.a. “welfare for all.” This is of course a re-hash of the Keynesian Cargo Cult’s 1930 fix for the Great Depression, except on a far grander scale.

There are three completely unsupported assumptions in every proposed “welfare for all” scheme:
1. The trillions of dollars/ euros/ yen etc. required to fund “welfare for all” can be raised from taxing profits and wages. Yet wages and profits are both set to decline sharply in the near-term as the global recession tightens its grip and longer term from the unstoppable forces of automation.
2. Paying people to do nothing will free people to become artists, entrepreneurs, etc. This is a noble ideal, but if we look at communities that have become dependent on top-down central-state welfare, we find despair, social depression and the collapse of real community.
“Welfare for all” debilitates the community by stripping away the sources of meaningful work and positive social roles. I explain this further in my book A Radically Beneficial World: Automation, Technology and Creating Jobs for All.
3. Though few if any supporters of “welfare for all” schemes state this directly, the underlying assumption is that “welfare for all” is a temporary measure to get the unemployed/under-employed through a rough patch, and that the economy will magically heal itself and create millions of new jobs if given time.



Perhaps the biggest thing we need to do is to stop lying to ourselves.  We have to admit that the party is over and clean up the mess before it gets dumped on our kids.

The bear will soon be arriving in earnest, marauding through the canyons of Wall Street while red in tooth and claw. Our monetary central planners, of course, will once again—for the third time this century——be utterly shocked and unprepared. That’s because they have spent the better part of two decades deforming, distorting, denuding and destroying what were once serviceably free financial markets. Yet they remain as clueless as ever about the financial time bombs this inexorably fosters.

The sum and substance of Keynesian central banking is the falsification of financial prices. In essence, this means pegging interest rates below market clearing levels on the theory that more borrowing and spending will thereby ensue.

To this traditional credit channel of monetary policy transmission has been added in recent years the notion of an FX channel, which works through currency depreciation and export stimulus; and the wealth effects channel, which seeks to levitate the paper wealth of the top 10% of households so that they will feel emboldened to spend more at luxury retail emporiums, BMW showrooms and upscale vacation spots.

Needless to say, currency trashing might work for a tiny export economy like New Zealand. But on a global scale among the big national economies, it’s just a recipe for a race to the bottom. Ultimately it leads to nothing more than the inflation of imported commodities and goods and the reallocation of income and wealth from domestic industries and households to exporters and their shareholders.  Japan proves that in spades.



The U.S. Economy Is Finally at Full Employment


There are paths out of the mess.  They aren’t hard to find. Just put Keynes in the garbage can that it belongs in and start talking to people.  No more stimulus and rents to the already wealthy.  Instead you need tax cuts to make money cheaper, especially taxes on incomes and low corporate tax rates to lower prices.  You need to kill the regulations that create endless compliance time vacuums and kill innovation.  Basically everything that we think and know about the economy needs to be rethought and the light of reality needs to be shined on economic thinking. Otherwise it  will not end well.

For more on the dysfunctional economy click Here or on the tag below.

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