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Why Government Stimulus Sometimes Looks like It Revives the Economy

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Once an economy falls into an economic slump and the level of unemployment begins to rise most commentators are of the view that it is the duty of the government and the central bank to step in to counter the rise in unemployment. Some commentators are of the view that the lowering of unemployment can be achieved without any cost given that the unemployed individuals are idle. According to Paul Krugman,

If you put 100,000 Americans to work right now digging ditches, it is not as if you are taking those 100,000 workers away from other good things they might be doing. You are putting them to work when they would have been doing nothing.1

But how will this “lowering’”of unemployment be funded? Who is going to pay for this? It seems that Krugman and other commentators are of the view that funding can be easily generated by the central bank by means of printing presses.

But, contrary to Krugman and other commentators, funding is not about money as such but about real savings, which is the amount of consumer goods produced less the consumption of these goods by their owners.

Real savings sustain producers in various stages of production. When a baker trades his saved loaves of bread for potatoes, he in fact provides a means of sustenance to the potato farmer. Equally, the potato farmer provides a means of sustenance, his saved potatoes, to the baker.

In order to maintain their lives and well-being what people require is final goods and services and not money as such, which is just a medium of exchange. Money only helps to facilitate trade among producers—it does not generate any real stuff. Paraphrasing Jean-Baptiste Say, Mises wrote,

Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.2

The various tools and machinery or infrastructure that people have established are for only one purpose and that is to be able to produce the final consumer goods that are required to maintain and promote their lives and well-being.

The greater the production of consumer goods, all other things being equal, the larger the pool of real savings is going to be. A larger pool of real savings can support a greater number of individuals who are going to be employed in the enhancement and the expansion of the infrastructure. This means that through the increase in real savings, a better infrastructure can be built, which sets the platform for a higher economic growth.

The savers here are wealth generators. The savings of wealth generators are employed to fund various individuals who specialize in the making and the maintenance of the infrastructure. (Real savings also fund individuals who are engaged in the production of final consumer goods). Contrary to Krugman and other commentators, the artificial creation of employment such as digging ditches is not going to be cost-free. Various individuals employed in non-wealth-generating projects must be sustained, i.e., funded. Since government does not produce any real wealth, obviously it cannot save and therefore it cannot fund any activity. Hence for the government to engage in various activities it must divert funding, i.e., real savings, from wealth generators.

Increases in Production Are Limited by the Increase in Real Savings

Can an increase in the demand for consumer goods lead to an increase in the overall output by the multiple of the increase in demand as suggested by Krugman?

To be able to accommodate the increase in his demand for goods, a baker must have the means of payment, i.e., bread, to pay for goods and services that he desires. For instance, the baker secures five tomatoes by paying for them with the eight saved loaves of bread. Likewise, the shoemaker supports his demand for ten tomatoes with a saved pair of shoes. The tomato farmer supports his demand for bread and shoes with his saved fifteen tomatoes.

Whenever the supply of final goods increases, this permits an increase in demand for goods. Thus, the baker’s increase in the production of bread permits him to demand more of other goods. In this sense, the increase in the production of goods gives rise to demand for goods.

Note again that what enables the expansion in the supply of final consumer goods is the increase in capital goods or tools and machinery. What in turn permits the increase in tools and machinery is real savings. We can thus infer that the increase in consumption must be in line with the increase in production. The increase in production is in accordance with what the pool of real savings permits.

Production cannot expand without the support from the pool of real savings. This of course means that only wealth generators can set in motion an expansion in real wealth.

Why Data by Itself Cannot Produce Facts

How, then, are we to reconcile the so-called facts that are supposedly presented by various studies, i.e., that stimulus programs can grow an economy?

Contrary to the popular way of thinking, data cannot talk by itself and present the so-called facts. The data must be assessed by means of a framework that can withstand some basic scrutiny such as whether the government while not being a wealth generator can grow the economy.

Once we reach the conclusion (based on logical analysis) that the government cannot grow the economy, we can emphatically reject various studies and assertions that tell us the opposite.

The data, out of which various so-called facts are produced, appear to be supportive of various empirical research conclusions as long as the private sector of the economy generates enough real savings to support productive and nonproductive activities. As long as this is the case, various so-called empirical studies can produce “support” for the theory that the government can grow an economy.

But whenever the ability of wealth generators to produce real savings is curtailed, economic growth follows suit, and no amount of money that a government pushes into the economy can make it grow. (Again, the government cannot generate real savings; it can only divert the existing real savings from wealth generators.)

Once the process of wealth generation has been damaged and loose policies become ineffective in “reviving” the economy various commentators are quick to suggest that the laws of economics must have changed. For them this means dismissing the logical analysis based on the essential laws of economics and pleading for massive spending by authorities.

According to Krugman,

We are at unusual times where usual intuition doesn’t apply here, getting this economy moving is the best thing we can do, not just for the present, but for the future and for our children.3

What we can suggest here is that if the pool of real savings is in trouble, then adopting Krugman’s advice, i.e., introducing a massive fiscal stimulus package, will only make things much worse and plunge the US economy into a much more severe economic slump.

If the pool of real savings is still holding, then there is no need for stimulus programs—the growing pool of real savings will revive the economy.

After closing at 103.4 in Q3 2003, our proxy for the pool of real savings has been following a visible downtrend—closing at 100.8 by Q3 2020.

This estimate of the pool of real savings suggests that more government and central bank stimulus policies are likely to further weaken the pool of real savings and place the economy on the path of a prolonged economic slump.

  • 1. Paul Krugman, “Krugman on Stimulus Package Impact,” interview by Maria Bartiromo, Closing Bell, CNBC, Aug. 30, 2010, https://www.cnbc.com/video/2010/08/30/krugman-on-stimulus-package-impact.html.
  • 2. Ludwig von Mises, “Lord Keynes and Say’s Law,” in The Critics of Keynesian Economics, ed. Henry Hazlitt (Lanham, MD: University Press of America, 1983), p. 316.
  • 3. Krugman, ”Krugman on Stimulus Package Impact.”



Source: https://mises.org/node/52912


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