Why Biden’s big virus-relief bill won’t help the economy | Peter Crabb column

It’s just not what the doctor ordered.

The doctor in this case is economist John Maynard Keynes, and the prescription is the recently passed American Rescue Plan Act of 2021, the “supplemental appropriations” for COVID-19 pandemic relief. The side effect of this prescription will be higher taxes.

Passage of this coronavirus legislation is a direct application of Keynesian economics. Keynes’s 1936 treatise, “The General Theory of Employment, Interest and Money,” explained how the fiscal policies of the government could possibly stimulate economic activity when production and employment were low.

The Keynesian policy implication for a weak economy is straightforward: The government should step in to increase overall demand. Government should buy what firms are producing, so that workers can keep working and consuming.

Keynes wrote his theory in response to the economic problems of the early 1930s. Employee layoffs around the world at the time supported Keynes’s idea that wages were not adjusting to slowing demand.

In some recessionary periods of the past, the predictions of Keynes’s theory played out. Rather than a reduction in wages, the economy experienced a high number of layoffs and increasing levels of unemployment. However, Keynes’s “medicine” of more government spending didn’t always pan out.

In response to the last recession of 2008 and 2009, Congress appropriated large sums of economic “stimulus”, thereby running the largest budget deficits since World War II. However, the U.S. economy responded to this new government spending by growing slower than normal. According to the U.S. Bureau of Economic Analysis, the economy operated below potential from 2009 through 2017.

So what would the doctor order now?

Keynes wrote that if employment was near its natural rate and inflation low, the government should spend less and reduce debt. The federal government hasn’t run a budget surplus in nearly 20 years.

If more spending is not what Keynes would call for today, the likely effect of the new legislation is a return to slow growth. This is due to what economists know as a crowding-out effect. Harvard Economists Robert Barro and Charles Redlick demonstrated that when the government increases spending, whether by raising taxes or borrowing more from the public, there is no effect on overall consumer and business demand. In response to the new policy, households save more in expectation of higher taxes.

Government spending gets in the way of, or crowds out, private spending.

Even if Keynes was right for his times, more Keynesian spending today is not an effective medicine, just an indicator of more taxes tomorrow.

Peter Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. prcrabb@nnu.edu

This story was originally published March 16, 2021 at 4:00 AM.