Heritage Still at the Cutting Edge

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.

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13 thoughts on “Heritage Still at the Cutting Edge

  1. Jonathan

    Did you notice he refers to payroll tax cuts – tax cuts!! – were failed Keynesian stimulus. He slides through that bit of heresy by saying the cuts were, in essence, negated by borrowings. That’s an expression of a purity of concept which doesn’t bode well for the nation because adherence to stricter and stricter orthodoxy poses greater and greater conflict with reality. If I read that guy correctly, he’s really saying that you need to cut spending for a tax cut to work. I’m not sure he meant to say that because he was working so hard to discredit Obama no matter what, but it’s in there nonetheless.

  2. Paul Mathis

    Heritage Foundation You Say?
    Dr. Foster is much better known for his blog:
    AntiObamaBlog.com where you can read all his right-wing nonsense in one convenient place. NO Need for searching!

  3. 2slugbaits

    I seem to recall that Heritage claimed they were using the IHS Global Insight macro model, but the folks from IHS Global Insight said that they could not understand how Heritage arrived at their results using the IHSGI model. It sounded like Heritage modified the IHSGI model to accept a magic asterisk parameter.

  4. Dr. Morbius

    The mathematical expression confuses me so I produced this narrative form of the Heritage Total Demand Function instead:
    Total Demand = what the ultra rich want to buy + bare subsistence for the 99.5%.

  5. Markg

    So the govt borrows (lets say $100) from me. I get a $100 US Svings bond, but I am out $100 cash. Of course the govt spends the money; why would it borrow it if it did need it for spending. So the govt cuts me a check for $100 for a good or service I provide to the govt. So at the end of the day, I still have $100 in cash to spend plus I have $100 in savings. I feel so good about this extra savings I go out and spend $100 in cash. Demand has increased from govt borrowing.
    Now replace the “I” above with “private sector”. The above example is just to show a point. Of course there are multiples involved that are far less than 2. And the govt can and does waste real resources so this is not to say the govt can run around spending out of control. Add one more Ph.D. to the list of idiots in the world!

  6. Brad Bannister

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  7. Ricardo

    Is it more dangerous for the Heritage Foundation to write, “The [basic Keynesian] theory fails because it relies on the unstated fantasy government can magically create demand out of thin air,” or for the Federal Reserve and the Treasury Department to implement policy based this “basic” theory?

  8. BH in MA

    “If the government borrows money, that money won’t be available to be spent by companies and individuals.” Doesn’t the fact that the government can sell 10 year bonds at 2% interest suggest that companies and individuals are NOT INTERESTED in spending the money they have and would rather keep it in government bond or money market funds until things get better?
    The assumption that the government borrowing $100 from me will reduce my consumption by $100 requires that I was going to spend that $100 and have no other savings availabe. Why would I loan the government money I was planning to spend?
    Yes, if you trade a trillion dollars in cash for government bonds, that cash is no longer available to be spent. But you can’t assume it was going to be spent. And in this environment it was likely NOT going to be spent. So now it’s in the government’s hands and they’re not “maybe going to spend it someday if things get better.” They’re going to spend it. “But they’re going to spend it on the wrong things,” scream those who believe the government can’t do anything right ever. Yeah, well, it’s going to be spent. It’s going to end up back in the hands of people and businesses and the government will have some goods and services to show for it. And a bunch of extra people will have jobs and pay taxes as a result. Besides, how wrong could they be? We’ve known for years that our infrastructure needs upgrading. So upgrade it. I’ve listened for decades to politicians tell us that it’s too expensive and that we (the richest nation on earth) can’t afford it. Well, we’ve got high unemployment, low interest rates and low capacity utilization. THIS IS WHAT IT LOOKS LIKE WHEN IT’S CHEAP.

  9. Anonymous

    “If the government borrows money, that money won’t be available to be spent by companies and individuals.” Doesn’t the fact that the government can sell 10 year bonds at 2% interest suggest that companies and individuals are NOT INTERESTED in spending the money they have and would rather keep it in government bond or money market funds until things get better?”
    Do you not understand the Fed is manipulating bond rates? What would bond rates look like if the Fed did not purchse 60%+ of them?

  10. Ricardo

    “Maintaining a coordinated structure of production is essential for maintaining a given level of prosperity, and lengthening the structure is a necessary condition for an improvement in the material standard of living. When one fully incorporates capital theory into macroeconomic analysis, it becomes clear that consumption is not the “engine of the economy…” Professor John Cochran
    “…any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed. Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.” Murray Rothbard
    “The federal government has expanded from a bloated 18–20% of the economy to 23–25% of the economy under the current administration.” Thanks to the tag team Barak Obama and Ben Bernanke
    With consumption up, maintenance, replacement, and expansion of production are down 5% of the total economy. Lost production is lost forever.

  11. Rick Stryker

    Another reasonable, balanced, and insightful article from Heritage. They are on a roll. As I read it, Foster does indeed have one of the modern dynamic models in the back of his mind. His argument is similar to those made by Cochrane and Fama. In those cases, Krugman also accused them of not understanding the basic Keynesian model taught to undergraduates. But I think Foster understands it well and is just rejecting it, just like Fama and Cochrane.
    This post may have set a record for the most bizarrely irrelevant comments from Menzie’s left wing chorus.

  12. mock turtle

    fosters article doesnt significantly differentiate between spending during periods of deep recession versus periods of high private consumption…nor does this piece take into account different kinds of government spending…cutting edge science research, needed transportation infrastructure, 21st century energy, as opposed to purchasing “bridges to nowhere”
    the blanket proposition that the level of government spending has no significant effect on economic output…. under all circumstances… is silly on its face
    mock turtle

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