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Fed Economist Smacks Down Keynesian Blinder on Deficit

August 29, 2013 By Young Research

After Alan Blinder recently wrote a spectacularly Keynesian piece in the Wall Street Journal op-ed section arguing for more deficit spending, VP and Economic Advisor of the St. Louis Fed, Daniel Thornton eviscerated Blinder’s claims in a short report. Below are some quotes from Thornton in response to Blinder’s claims that short term deficit spending increases will increase output without affecting long term growth.

  1. Additional deficit spending need not increase output for two reasons. First, increased deficit spending increases the supply of bonds, which reduces bond prices and increases real bond yields. Higher real bond yields reduce consumption and investment spending.
  2. Second, deficit spending may not affect private spending because of Ricardian equivalence, named after the classical economist, David Ricardo. The basic premise is that current tax cuts must be paid for with future tax increases in order to repay the additional debt incurred today.
  3. Increased deficit spending can have no permanent effect on output. In short, government debt cannot be considered net wealth by all U.S. households. If it could be, then we could all become infinitely wealthy simply by incurring an infinite amount of debt. Just as with fiat money, you cannot simply print your way to long-run prosperity.
  4. Additional deficit spending reduces economic growth by crowding out capital investment. A smaller stock of capital means less future output. This is an intergenerational transfer: People today get more output, while those in the future get less. It seems likely that such a loss of future output could easily swamp any (temporary) increase in current output.
  5. The positive effect on output is problematic and temporary, while the negative effect on economic growth is long-lived.
  6. The idea that more will be produced if more is demanded is easy to understand. The belief that additional deficit spending will somehow cure the current problems—an unusually slow rate of output growth and an unusually high rate of unemployment—by stimulating innovation and capital spending is not.

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