Another Nail In the Keynesian Coffin

From: Real Clear Markets

The coffin of Keynesianism has so many nails in it now that it is practically surfaced in steel. The notion that government deficits "stimulate" demand, has been proved wrong so many times, and in so many ways, that you would have to be Paul Krugman to still believe in it. However, in its April 28 news release on 1Q2011 GDP, the BEA drove yet another factual wooden stake into Keynesianism's vampire heart - a stake that no one seems to have noticed. What happened should also serve as a warning to Republicans that are still in the grip of the Keynesian superstition.

The BEA reported that its first estimate of 1Q2011 real GDP growth was 1.8%. This represented a dramatic fall from 4Q2010 growth of 3.1%. What no one seems to have noticed is that the slowdown occurred in the face of another large dose of Keynesian stimulus.

Part of the leverage that Republicans had during the negotiation of the compromise on the Bush tax cuts was that the Democrats (Keynesians all) were concerned that Obama's $814 billion "stimulus" program was winding down. The Republicans ultimately got Obama to agree to extend the tax cuts for high earners for an additional two years in return for additional "stimulus", in the form of a one-year, two percentage point cut in the payroll taxes paid by workers.

In 1Q2011, this stimulus amounted to about $110 billion on an annualized basis, or about 0.73% of GDP. Given the Keynesian belief in "multipliers", the result should have been to increase 1Q2011 real GDP growth significantly over that of 4Q2010. Instead, the real growth rate fell, thus providing one more real-world confirmation that Keynesian stimulus doesn't work.

The real mystery is not that stimulus doesn't work, but why anyone would ever expect it to. After Obama signed the compromise bill on December 17, 2010, one of the first things that the Treasury did was to revise its borrowing plans upward to compensate for the reduction in tax revenue that it knew was coming on January 1, 2011. Additional bonds were sold, and extra money was withdrawn from the economy before the payroll tax cut showed up in workers' paychecks. If there was any impact upon demand at all, it was to reduce it.