The Deficit Spending Question

There’s a lengthy post on the effectiveness of fiscal stimulus by deficit spending over at Clusterstock:

We’re left with a couple questions. (1) Is it true that government stimulus is a waste of time and money? That cutting the deficits in Europe will likely result primarily in fewer imports, that raising the deficits in the US will result in more jobs in China and more structural unemployment in the US? That Paul Krugman and Ben Bernanke are wrong, wrong, wrong, and all Krugman’s proposed stimulus spending will wind up getting soaked up either by Bernanke’s Quantitative Easing which turns it into stagflation, or by Chinese buying American Bonds and American Jobs?

The second question is, (2) If neither Keynesian spending programs nor Monetarist interest rate manipulations and quantitative easing will generate jobs, then what will pull us out of this world-wide recession, what will keep us from slipping into a full blown world-wide depression? Unfortunately, history does give us some guidance here.

During the Great Depression, every kind of economic policy you can imagine was tried. Just as Europe is cutting their deficits today, the US cut their deficits in the early 1930s. It didn’t have much effect. Just as the US is deficit spending today, the US under Roosevelt deficit spent in the later 1930s, and that had little affect. What finally ended the Great Depression was World War II.

In WW II, Roosevelt gathered up 1,000,000 unemployed men and shipped them off to Europe. Then he gathered up another 1,000,000 people and put them to work building tanks, ships, planes, ammunition. Finally, he put major rationing programs into place, making certain that the money he spent didn’t go into consumption, rather it went into savings and then immediately into business investment.

To be honest I’m skeptical of the “World War II ended the Depression” notion for a couple of reasons. First, it suggests that a command economy would be able to solve our economics problems since, after all, that’s what we had during the war. Second, it’s a post hoc propter hoc argument. Finally, it smacks of the parable of the broken window. How much more economic growth might we have seen had the world not gone to war? We’ll never know.

That command economy did lay the groundwork for the massive distortion of the market we’ve been living with ever since. That is what Ike’s “military-industrial complex” speech warned us of. That distortion is only now being overshadowed by an even larger market distortion, something we might call the medical-industrial complex.

I doubt we will ever be able to be confident about an explanation of what ended the Great Depression. The answer, unsatisfying as it might be, is in all likelihood the business cycle. Perhaps it would be better to ask what prolonged the Great Depression? In all likelihood it was the very same things that are now prolonging the Great Recession. There is only so much deadweight loss that an economy can endure before growth becomes very, very difficult.