Why do Keynesians Think More Spending will Stimulate the Economy?

My Twitter followers are constantly asking me if I think more spending would really help the economy recover. I understand their skepticism. Many are probably struggling with high debt levels, and the last thing they want is some economist urging them to rack up more debt for the good of the economy. (Bad advice, indeed.) Others have heard President Obama talk about putting Americans back to work by investing in our nation’s infrastructure, educational system, energy future, etc., but many aren’t sure if the “stimulus even worked“, so they, too, wonder if more spending is really the right way to grow the economy. Well, here’s the answer.

Spending isn’t the just the right way to grow the economy, it’s the only way.

After all, what is “the economy”? For most economists, it’s a simple number. We use a country’s Gross Domestic Product (GDP) to measure its “economy.” So where does this GDP come from?

There are different ways to calculate GDP, but each method is designed to yield the same result. Let’s look at the most popular method — the one based on expenditure. GDP basically measures the total amount of spending (at market prices) on newly-produced goods and services (by their end users). In other words, GDP measure how much money we spend.

Who’s “we”? All of us. You and I belong to the household sector, and together with our friends and neighbors, our Consumption Spending normally accounts for about 70 percent of the expenditure that comprises our GDP (go team!). The business sector is important too, because that’s where Investment Spending comes from — the factories and office buildings most of us work in and the computers and machinery we use to make things. State, local and federal Government Spending also gets counted in GDP because they pay salaries, order supplies, buy aircraft carriers, etc. Finally, there are the things we import from foreign producers (European vacations, business travel, a foreign-made automobile) and the things we export to foreign consumers, businesses and governments. On balance, our Net Exports (Exports – Imports) are another potential source of GDP.

So how do we “grow the economy”? By increasing our GDP. And how do we do that? By increasing one or some combination of the four components of GDP:

1. Consumption Spending
2. Investment Spending
3. Government Spending
4. Net Exports

Without an increase in one (or some combination) of these components of total spending, GDP cannot increase.

Now for the hard part.

MULTIPLE CHOICE: Who is in a position to lead us out of this weak recovery?

a.) Household Sector (currently deleveraging – i.e. paying down debt)
b.) Business Sector (hesitant despite low borrowing costs and mountains of cash)
c.) Government Sector
1. State/Local (still struggling with shortfalls)
2. Federal (currency issuer that can spend more when others cannot/will not)
d.) Foreign Sector (China, India, Brazil, Eurozone, Russia, UK)

About Stephanie Kelton 24 Articles

Affiliation: University of Missouri

Stephanie Kelton, Ph.D. is Associate Professor of Economics at the University of Missouri-Kansas City, Research Scholar at The Levy Economics Institute and Director of Graduate Student Research at the Center for Full Employment and Price Stability.

Her research expertise is in: Federal Reserve operations, fiscal policy, social security, health care, international finance and employment policy.

Visit: Economic Perspectives

14 Comments on Why do Keynesians Think More Spending will Stimulate the Economy?

  1. a.) Household Sector (currently deleveraging – i.e. paying down debt)
    /can’t, fewer households have employed members.
    b.) Business Sector (hesitant despite low borrowing costs and mountains of cash)
    /won’t, uncertan of effect government rules and and AHC law.
    c.) Government Sector
    /has spent $6 Trillion more than taken in over the last 4 years it has added 60% of what the debt was to the debt now with nil results. The spending selected was wasted with almost no lasting jobs nor products domestically produced.

    1. State/Local (still struggling with shortfalls)
    /can’t, already bankrupt!
    2. Federal (currency issuer that can spend more when others cannot/will not)
    /already did, QE 1 and 2 with very little to show for it
    d.) Foreign Sector (China, India, Brazil, Eurozone, Russia, UK)
    /Each nation is having their own economy problem

    So just spending by the Feds is not the answer. Yes, it is the only agency that can print money but that causes inflation unless there is value behind the new money. The Feds will not either make business conditions more attractive for investments. Until the Feds do make the business environment more attractive for investment there will not be any investment.

    • Demand makes the business environment more attractive for investors. The fed can only make the business environment more or less attractive to criminals.

    • You are assuming the stimulus spending did not work:

      (a) the majority of the stimulus returned a profit so there will little to no net debt incurred; that which has not, so far, returned a profit is the bailouts of car manufactures
      (b) no one can predict where the economy would have been with out it. It is more probable the economy would be much worse.

      And, no I am not a liberal. Just a realist.

    • “the majority of the stimulus returned a profit”

      ?? Revenue has no meaning to an issuer of fiat currency. Ergo, neither does profit or loss. The only metrics that matter are the real ones. Employment, output, capability.

  2. If it was that eazy, why not throw 100 Tillion at the economy so everyone can buy lots and lots of stuff and the GDP will be the highest it has ever been and we will have a booming economy like no one have ever seen before in the history of man kind.

    The truth of the matter is; that spending creats huge debt and increasing the money supply cause s inflation and that erodes wealth. The debt increases till everyone ends up like Greece with 35% of the population living in total poverty.

    The west has been living beyond its means. The east is booming and the west is going down hill fast. The only way to reverse this is to cut wages. I suggest that CEO bonnues get cut first.

    • When you throw money you have to throw it to people that aren’t already rich if you want the economy stimulated, rich people just pile it up with the money they have. When you give it to the poor you need to make them earn it building infrastructure that is so badly needed.

      People complain about the redistribution of wealth, it already happened and is the reason we are where we are now. The wealthy are sitting on all of the money wondering why the poor won’t spend and pay more taxes.

      When all of he wealth was lost in the housing collapse it was not destroyed, someone has it and they will not be made to give it back. The CEOs are laughing at the world they took all of the money and had the government replace it so they could pass out more huge paychecks to people who have never done an honest days work.

  3. Good article. There’s a tremendous opportunity to invest in our decaying and aging infrastructure which can be one way to create jobs and stimulate growth. I would also encourage the restructuring of our federal budget to reassign some of the military spending on domestic green energy projects.

    I would also ask our current elected federal officials to take a one year salary cut (50%) and put the money into WPA style jobs to rebuild communities devastated by foreclosed homes. I would then look to the private sector execs to show the leadership and create a pool of funds for the same purpose (even a 25% cut in salary can represent billions in funding).

    President Obama can lead by example and so could some high profile CEO’s.

    Harry C Tabak

  4. High GDP is not directly my goal. I want increased prosperity. Double the number of USD that exists, and give everyone an equal shared. I bet you GDP will double. Woopty do GDP doubled! But what happens to the motivation of people who had in the past worked hard to earn what once required hard work to attain (USD)? USD would then be worth much less.

    What’s really important to a living being (such as a human) is that production and reception of values exceeds consumption and loss of values. Productivity exceeding consumption results in living success. Consuption exceeding productivity results in death. Increasing productivity significantly beyond consumption results in prosperity.

    Increasing the money supply results in destruction of value of savings denomiinated in that money. This results in people’s desire to decrease saving (increase spending/consumption and decrease production). This is the current siituation across the globe: money printing and nobody wants to work when you can just get hand outs–and the money that you might work hard for and save today will become worth the effort it takes for others to get handouts.

    What can we do to increase people’s motivation to produce? Discontinuing allowing currupt private government privaleged bankers to get first dibs on newly created money would be a good start. Next would be to make competing currencies legal, so that we are no longer forced to accept newly created USD as payment. Then we can trade and save using currencies that have more stable (more slowly increasing) money supplies. Finally our savings would be protected, and it would once again be worth producing beyond enough to meet today’s needs!

  5. Your article is idiotic. Your main logical fallacy is that money is somehow independent of productivity. An economy grows because the productive contributions of the parts increase. If the government borrows money to finance stimulus, the net productive contribution is negative because of the carrying cost of the debt. GDP, as a measure of economic strength, is fatally flawed because it doesn’t measure productive contribution but spending.

    To simplify for the economists who may read this post:
    1. People and economies do not get rich by spending. Wealth is created by producing. Production leads to wealth and wealth then leads to spending.
    2. If you spend without producing, poverty is the result. It isn’t some fancy economic theory, it is simple math.

  6. And why is Business Sector hesitant? Heavy Boot of gov’t on its throat through thousands of indecipherable, arbitrary, and conflicting regulations and laws. Uncertain tax laws. Why are state/local gov’ts struggling with shortfalls? new unconstitutional mandates by the federal gov’t that eat up their budgets (medicaid, etc.) The Fed sure hasn’t stopped printing money to devalue our currency and you want them to do more?

    Only answer is for gov’t to reduce spending and lift the regulatory and tax burden off of business and individuals that will allow free markets to work.

  7. What Steph is suggesting is exactly what “we” (and by we I mean our Federal government) has been doing since the financial collapse (actually it started long before that, but in the context of a recovery plan, it’s relevant to focus on the time after the collapse). To understand if more of this would help, you only have to go back and look at the last 4 years. It really all comes down to what you are trying to accomplish.

    If you want to truly repair America, forcing it to finally deal with the real reasons of why the collapse happened and what we can do to repair our economy so it can grow again, then more of the same we have already seen is not the answer. But, that would mean accepting some inevitable contraction, and dealing with the backlash of a few quarters of negative GDP. But at least America could finally get back on track, and you would have some real, tangible, improving numbers to hang your hat on, and finally see additional jobs for those Americans in need.

    Or, we could go the more borrowed/debased spending route, the same one we have been on, and see more annual trillions added the the debt load, more quarters of sub 2% GDP improvement (that will all be easily tied to the government spending, stimulating nothing), and a UE rate above 8% for years to come.

    Seems like an obvious choice to me.

  8. Steph,
    Why not cut through more of the clutter and remind people that the “government” in the end isn’t anyone other than us.

    “Federal” spending, in the end, is public initiative.

    In any social species, any tribe, any nation, public initiative is what you have when individual initiative isn’t enough. It’s called the return on coordination.

    That’s a simple reality. In economics, why is there such a Gaping Separation Between Theory and Operations?
    http://econintersect.com/b2evolution/blog2.php/2012/08/30/in-economics-a-gaping-separation-between-theory-and-operations#c4679

  9. Money alone does not generate wealth in an open economy. If you spend more and companies are not competitive, you increase imports and debt.
    So, you must improve competitiveness in the real economy. How about lowering taxes for non-financial companies?

  10. Like to add just a caveat to spending as a means of goosing the economy. Spending does work overall obviously. However, where and how you spend is critical. Whereas we ‘spent’ to save the banks and that cash just flowed into the vaults and pockets of bankers, perhaps we should have sent that cash right to the struggling homeowners, who would have spent it rather than hoarding. And then there is our Military budget…The sacred cow that no congressman wants to address, which consumes a considerable amount of our GDP without producing anything aside from the animosity of peoples around the world. How much better would we be if we diverted that absurd expense into a new power grid, real alternate energy, cohesive and complete mass transit and a high speed internet…All things that would aid our economy and our quality of life.

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