I recall the advice that Larry Summers offered when we were debating this issue last January:On the other hand, there's this news out of England.First, to be effective, fiscal stimulus must be timely.... Second, fiscal stimulus only works if it is spent so it must be targeted.... Third, fiscal stimulus, to be maximally effective, must be clearly and credibly temporary-- with no significant adverse impact on the deficit for more than a year or so after implementation.Although our current situation is more serious than the one we faced a year ago, I still believe that this is a correct articulation of the core principles to keep in mind ... I think Obama's announcements today may be just what the doctor ordered.
There is now a palpable fear that global investors may start to shun British debt as the budget deficit rockets to £118bn - 8 per cent of GDP - or charge a much higher price to cover default risk ... Labour ran a budget deficit of 3pc of GDP the top of cycle. (We had a 2pc surplus at the end of the Lawson bubble, so we go into this slump 5pc of GDP worse off). The size of the state has ballooned from 37pc to 46pc of GDP in a decade, and will inevitably now rise further.It's worth noting that the US deficit and debt are higher that Britain's.
It is because Gordon Brown exhausted the national credit limit to pay for his silly boom that today's fiscal stimulus - just 1pc (per cent) of GDP (China is doing 14pc) - is enough to rattle the bond markets. Our national debt will jump in what is more or less the bat of an eyelid from under 40pc of GDP to nearer 60pc ...
Keynesian economics tells you to borrow and spend when times are bad. However, there's an upper limit to that - an upper limit when everyone is so totally in debt that more borrowing produces no effect. In time, all of your borrowing goes to pay the interest on your previous borrowing and none of it goes to stimulation. As a reference point, the federal government now pays about $300B per year on interest on the debt. That will jump with these new, monstrous deficits.
What's the end goal look like for these stimulus packages? If the economy starts growing at 1% (robust growth by socialist European standards), but our interest payments are $500B per year, are we really better off? Does anyone, anywhere believe that these policies will ever lead to paying down the debt?
Update: Manchester blogger Dominic makes this point: "Keynes was born in a world where government spending was under 20% of GDP, Keynes studied in one of the largest conflicts the world had ever seen, when government spending was on average 25% of GDP."
Update 2: James Hamilton's readers are not so sanguine about Obama's choices.
If the above is the best Summers has to offer we are in big trouble. Timely, targeted, and temporary - does this mean whether the actual policy is good or bad. This is inane; it has no economic meaning. This could be said about Thanksgiving Dinner and be just as intelligent. Summers has extreme Keynesian ideas that will push consumption when our whole problem has been caused by government pushing consumption.