“There is no evidence that Keynesian fiscal injection solves long-term

structure problems in an economy”

Right diagnosis, Wrong Cure

Presented by : Tang, Yiyang, Pedro, Libabatie A., Orzolek, Benjamin

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Macroeconomics Key Concept

Background - Economic Stimulus

● Economic or "fiscal" stimulus/injection stands in contrast to monetary stimulus, as a process through

which the U.S. Federal Reserve Board adjusts interest rates to encourage or discourage lending.

● Economic stimulus is another means by which a Government can seek to boost its economy, in the
short term, by encouraging consumers or companies to consume goods

● In the longer term, fiscal injection is used by the government via encouraging and incentivizing the
growth of businesses and the creation of jobs through investments in infrastructure and research.

● Multiplier effect
○ Money injected into an economy by the government will have a greater per dollar effect
because the money circulates and is used each change of hand to stimulate economic growth.

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Prior to Keynes Economics

Historical Background - The Classical Argument

● Classical laissez faire economics tradition of Adam Smith has been variously continued by Neoclassical
/ Austrian School / Chicago school Economic Case (Smith, Say, Walras, Hayek, Schumpeter et al)
● Economies were organic, self-organising and guided by the “Invisible Hand” pricing mechanism and
self-rejuvenating via “creative destruction” i.e. the characteristic of economic business cycle.
● Essentially backing the microeconomic construct based around equilibria of demand and supply in
different markets being determined by price (and the profit motive).
● Thus Supply side orientedness: e.g. Say’s Law: Supply creates its own Demand (Additionally, any
unemployment is voluntary since workers refuse to accept lower wages)

KEY CLASSICAL CONCLUSION: THE MARKETS MUST BE LEFT TO EVOLVE FREELY WITHOUT INTERFERENCE

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Keynesian Economics - What is it all about?

● Keynes created the concept of Macroeconomics and its phenomena of government

spending, taxation, interest, inflation and overall economic growth (e.g. Gross
Domestic Product (GDP) growth).
● Keynes mainly focused on demand; thus it is from stimulating demand that market
recovery is expected to find its stability, not from encouraging value adding
production, i.e. supply. As such supply is assumed to be fixed in the short run and
the Keynesian proposition is to increase aggregate demand through, inter alia,
increasing government spending, reducing interest rates and / or increasing the
money supply to achieve a state of full employment across the economy.
● In the Short Run, the “Invisible Hand” doesn’t work because prices – and in
particular wages, the price of labour – are ”sticky”, i.e. don’t adjust quickly
● The principal problem created by this phenomenon is (involuntary).
unemployment, which is to be avoided since it represents a waste of resources and
can lead to (secular) social issues.
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How Keynesian Economics - Impacts Economic Growth

● It is important to note that, in most economies, the largest and most important element of GDP is consumer
spending, thus availability of credit (including via credit cards), mortgage rates and personal taxation (which will
affect disposable income are important data to monitor.

● In the domestic economy there are three elements of demand identified by macroeconomic theory:
consumption (represented by the letter “C”), private investment (I) and government spending (G).

● The equation found in economic texts round the world is that output (usually measured as Gross Domestic
Product or GDP) could be argued to be the single most important long run fundamental factor in financial
markets, given its very significant influence on the other main factors.

i.e. GDP = C + I + G + (X-M)

● Keynes fiscal injection emphasis was on aimed at G “government spending”

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 What’s wrong with Keynesian Economic Theory?

- The theory suggests that “Governments must intervene

via fiscal injection to support economic activity in the
absence of consumer or investment demand”.

- While Keynes generally envisioned public works

- These programs by the government often failed to
reduce unemployment or generate measurable
economic benefits.
- Instead, they exacerbate federal budget deficits,
- This is precisely the problem - Fiscal injection by the
threatening future economic growth by increasing
public indebtedness.
spending to stimulate the economy, most governments
on the contrary have embraced stimulus packages that
feature very little direct investments in infrastructure,
and instead focused more on welfare payments,
subsidies for troubled industries, and tax breaks
designed to encourage consumption.
government doesn't halt economic downturns. It just
postpones them and guarantees that an even worse
recession/depression follows. 6
Inherent Weakness of Keynesian Fiscal Injection

● The assumption that governments are more efficient spenders or that they are better equipped to
decide where money should be distributed/spent.

○ Which is counter to the free market foundations of our economy.

● It focuses on short term economic growth at the expense of the long-term economic growth and
sustainability.

● Keynes’ over-estimation of the impact the money multiplier effect has.

○ People and businesses have a higher tendency to save or hoard the money they receive by the
government instead of spending/circulating it. This reduces the multiplier effect of each dollar
spent.

● Keynes wanted to keep interest rates low to incentivize borrowing and lending to increase economic
investments.

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 The Presumption of More Efficient Spending by Governments
Some of the Present Majority Members in the Senate Budget Committee

Mike Enzi (R-WY) Chuck Grassley- (R-IA) Lindsey Graham (R-SC) Bob Corker (R-TN)
The Current Chairman
Some of the Present Minority Members in the Senate Budget Committee

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Bernie Sanders (I-VT) Marker Warner (D-VA) Kamala Harris (D-CA) Tim Kaine (D-VA)
Keynesian Fallacy - Fiscal & Monetary Policy Perspective

➢ Fiscal largess may inspire a temporary perception that the government is addressing the economic crisis, but
the consequences of ineffective policies and skyrocketing public indebtedness are often misunderstood and
drastically underestimated.
➢ Monetarists add fuel to the fire by injecting massive sums of cash into the market in order to suppress interest
rates and spur economic activity.
➢ By lowering the returns on holding cash, policy-makers hope to induce consumption and encourage capital
investment. Recent monetary easing programs have seen rates approach zero percent, but the impact on
economic activity has been debatable.
➢ The extensive liquidity injections in the beginning of the decade led to massive asset speculation, both in
housing and in mortgage backed securities. In an attempt to achieve higher returns, investors ignored default
risk as they plunged capital into mortgage and credit markets, engendering an easy credit environment that
created the housing bubble.
➢ Today, monetary policy is even more accommodative resulting in similar signs of excessive risk-taking in credit
and equity markets even without a sustained improvement in economic activity.
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 Keynesian economic fallacy… the case of the U.S. stimulus plan in context

The biggest failure in economics is the failure to foresee the long term consequence of a policy aka “fiscal
injection”

In Washington today, the failure of the Obama 2009 stimulus

package still lingers
- In 2009, President Barack Obama signed a $825 billion
stimulus bill into law with the promise of keeping the
unemployment rate below 8%.

- As of 2012, the 2012 U.S. Census data showed that over 12.8
million Americans unemployed, 1.1 million given up on job
search and 6.3 million Americans had fallen into poverty
clearly in contrast to the supposed fall below 6%

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Source: https://www.usnews.com/opinion/articles/2012/02/17/the-five-biggest-failures-from-president-obamas-stimulus-law
 U.S. 2009 Economic Stimulus

● The Obama Administration signed into law the almost $825 billion economic stimulus
package on February 17th, 2009.

The Unemployment rate was 8.3% in

February of 2009. It rose to 9.8% in February
of 2010 and then stayed above the initial
8.3% unemployment rate until February of
2012. This is all after President Obama had
told Congress that passing the stimulus
package would ensure the unemployment
rate would not rise above 8%.

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Source: The Bureau of Labor Statistics
No Longer Participating in the Labor Force

- The number of people exiting the labor

force increased sharply in 2009,
following the stimulus plan, and has
continued rising significantly since
then.

- From February of 2009 to February of

2018, approximately 11,708,000
additional people are no longer
participating in the labor force (i.e.
~3.6% of the US population ~325.7
million people). This is a contributing
factor to an increasingly deceiving
unemployment rate measurement.

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Source: The Bureau of Labor Statistics
Bigger Workforce, Yet Weaker Participation

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Source: The Bureau of Labor Statistics
U.S. Federal Spending Deficit

The 2008 recession

caused decreases in tax
revenue that began
increasing the federal
deficit. Obama’s 2009
stimulus package
increased borrowing
significantly that sharply
increased the federal
deficit. The amount of the
deficit must be balanced
somehow, often with an
increase in
borrowing/debt.

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Source: The St. Louis Federal Reserve
A look at some Statistical Dynamics : U.S. Debt-to-GDP

There was an almost

10% point increase is
debt-to-GDP ratio from
the first quarter of 2009 to
the first quarter of 2010,
followed by an additional
7% points increase to the
first quarter of 2011.

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Source: The St. Louis Federal Reserve
The Liquidity Trap

● A liquidity trap is when interest rates are set very low (approaching the zero lower bound) and
the rate of saving is, or remains, high.

● Instead of investing or lending, people and businesses will elect to hoard/save their money in
anticipation for what they assume will be an increase in interest rates because they will not be
decreased below 0% (the zero lower bound).

● The combination of low interest rates and high rates of savings typically makes monetary policy
ineffective in being used to combat the economic stagnation as the increase in money supply is
saved and not spent. This diminishes the money multiplier effect as the money does not
circulate as hoped/predicted.

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 The Liquidity Trap - Japanese GDP Growth Rate vs. Interest Rate

● Japan in the late 1980’s and early 1990’s experienced a severe asset bubble collapse that has triggered
what many consider a liquidity trap. Interest rates have been just above the zero lower bound, savings
has remained high, inflation has been very low, and GDP growth rates have been underwhelming.

QE1 QE2 QE3

03/01 03/10 04/13

Source: Trading Economics Source: the St. Louis Federal Reserve 17

Japanese Quantitative Easing and Inflation

Despite Japan’s repeated

fiscal stimulus packages, the
price level in 1993 is almost
the exact same as it was in
2014. In that same time
period, the supply of money
had over quadrupled in size.
The price level during QE1
actually decreased from
2001 to 2006.

Source: The St. Louis Federal Reserve (Chart 1)

https://research.stlouisfed.org/publications/economic-
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synopses/2014/01/10/quantitative-easing-in-japan-past-and-
present/
Japanese Debt-to-GDP Ratio

The Japanese government

and Bank of Japan must
finance these large fiscal
injections and they have done
so through borrowing.
Japanese debt has increased
in size to be 253% compared
to Japan’s total GDP. The
World Bank indicates that
Japan spent 12.67% of
government revenue on
interest payments in 2016,
which is including the fact that
Japan’s central bank lower
interest rates on this debt to
artificially reduce this burden.

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Via Trading Economics
Japanese Fertility Rate & Aging Population

● The liquidity trap has been exacerbated by the fact that Japan’s population is aging and the infertility
rate remains below a replacement level of 2.0. An older population tend to save more while healthcare
and retirement costs are increase for the population and the government.
Fertility Rate Percentage of Japanese Population 65 years and older

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Source: The World Bank
China’s GDP Growth Rate

Since November 2008, 4 trillion of Chinese Yuan

(approx. 585 billion USD) was used to stimulate the
economy: however, it exacerbates some pre-
existing problems, including the rising rate of debt
to GDP, and deveresing of Capacity of Utilization.

Source: Trading Economics

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Chinese Debt to GDP

Source: Trading Economics

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Capacity Utilization in China

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Conclusion

- Keynes economics is really designed for economic crisis management when the Invisible Hand pricing
mechanism has stopped working such as during the Great Depression.

- Artificial stimulus is used to restore confidence but should be removed as early as possible (cf. Fed Chair
Paul Volcker “my job is to take the punchbowl away just as the party gets going”).

- The key focus of Keynesian policies has been to alleviate the detrimental social impact of economic
downturns and particularly of unemployment which was a critical issue in the 1930’s.

- The risk remains however that the short term palliative of fiscal (and monetary stimulus) prevents the
economy from adapting towards a more sustainable future based around evolution and productivity.

"I guess we're all Keynesians in a foxhole“ Robert E. Lucas Jr.

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