Keynesian Economics Gets an “F”

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The idea behind Keynesian economics, as purported by the late British economist John Maynard Keynes and his followers, is that when the economy is in a recession, taxes should be cut and/or government spending increased to stimulate the economy and end the recession. Tax cuts give people more money to spend. Government spending creates jobs in the sectors of the economy that receives this spending. All this spending generates further income as the money is spent and re-spent. The stimulus thus ripples through the economy creating jobs, income, and promoting economic recovery. At least, that is the idea. Reality turns out to be quite a bit different.

According to the Keynesians, the $1.9 trillion American Rescue Plan that was signed into law on March 11 should have promoted economic recovery. At least one million new jobs were forecasted to be created in April, given the sheer volume of stimulus that was pumped into the economy. However, the April jobs report indicated that only 278,000 jobs were created that month. This would be a solid jobs report in a normal economic year. This is an abysmal jobs report when the economy is recovering from the worst recession since the Great Depression and nearly $2 trillion was pumped into the economy just a month before. Many forecasters pushed the forecast of massive job creation to May. However, May saw another disappointing jobs report with only 559,000 new jobs created. Forecasts of massive job creation have largely stopped despite these forecasts being key to win public support to pass the Rescue Plan. We have the unusual situation where nearly $2 trillion of stimulus was dumped into the economy with very little to show for it. The path of job creation is no different after the Rescue Plan than before it.

If the Rescue Plan was not successful in creating jobs, then what did it create? Unfortunately, it created inflation. The $1.9 trillion was financed by printing money. Most households got a $1,400 check and many got thousands more in child tax credits and other government aid. State and local governments collectively received $250 billion from the Rescue Plan. All these people are trying to spend this money at once, causing prices to rise.

This problem is compounded by the extended unemployment benefits passed as part of the Rescue Plan, as they reduce the incentive to work. Currently, there are seven million fewer jobs in the economy than pre-pandemic. This would indicate considerable slack in the labor market, yet workers are in short supply. “Help Wanted” signs are everywhere while nationwide, there are eight million job openings, a record high level. If these openings were filled, employment would exceed its pre-COVID high.

The Rescue Plan simulated demand while restricting supply, a classic recipe for shortages and inflation. Policymakers should not double down on the failed Keynesian idea by pumping even more newly printed money into the economy through future relief bills and bloated budgets.

 

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