From J.D. Foster, Ph.D., “Budget Cuts Would Not Harm the Economy” (February 14, 2013):
The [basic Keynesian] theory fails because it relies on the unstated fantasy government can magically create demand out of thin air. In fact, government must borrow to finance deficits, and all borrowing subtracts from the funds that would otherwise be available and used in the private sector for private investment or private consumption. …
…While budget deficits most certainly increase demand, the borrowing necessary to finance those deficits must dollar-for-dollar reduce demand. The net effect is more government debt but not more total demand and certainly not more jobs.
Those seeking to sustain the theory sometimes point to the possibility of importing more saving from abroad, thus avoiding the reduction in domestic private demand that must otherwise follow from the increase in government borrowing. To be sure, a net increase in imports of foreign saving likely financed some of the recent increase in budget deficits. However, it is also true the balance of payments must balance everywhere and always. As government borrowing rises and net inflows of foreign savings rise, so too must the net trade deficit—either U.S. exports must decline or U.S. imports must rise. In either event, once again total demand is unaffected though the composition of demand changes.
Recently, the Heritage Foundation has criticized me for caricaturizing their methodology, and insisting that they use modern, intertemporal approaches. This may very well be true, but thus far, I have not seen much evidence of this modern, intertemporal, approach in Heritage analyses.
I will, however, applaud Dr. Foster for moving from (T-G) + S ≡ I to (T-G) + (S-I) ≡ TB.