Not surprisingly, my recent article on “The Important Role Of Recessions” led to more than just a bit of debate on why “this time is different.” The running theme in the debate was that debt really isn’t an issue as long as our neighbors are willing to support continued fiscal largesse.
As I have pointed out previously, the U.S. is currently running a nearly $1 Trillion dollar deficit during an economic expansion. This is completely contrary to the Keynesian economic theory.
“Keynes contended that ‘a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.’ In other words, when there is a lack of demand from consumers due to high unemployment, the contraction in demand would force producers to take defensive actions to reduce output.
In such a situation, Keynesian economics states that government policies could be used to increase aggregate demand, thus increasing economic activity, and reducing unemployment and deflation.
Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.”
Of course, with the government already running a massive deficit, and expected to issue another $1.5 Trillion in debt during the next fiscal year, the efficacy of “deficit spending” in terms of its impact to economic growth has been greatly marginalized.
The main issue is that government spending has shifted away from productive investments which create jobs (infrastructure and development) to primarily social welfare and debt service which has a negative rate of return. As I showed on Friday, according to the Center On Budget & Policy Priorities, nearly 75% of every tax dollar goes to non-productive spending.