This is a serious question and just about everyone these days is assuming the answer is yes. I recently read a nice paper by John Taylor that argues that the use of countercyclical fiscal policy (other than automatic stabilizers) is not really desirable. But this is different from asserting that an increase in government spending per se does not increase total spending. I don't know whether Professor Taylor agrees with the argument I present below, but it has been a very long time since I have discussed this issue with anyone. The reason that I have not discussed it much with anyone is because, as Taylor points out in his paper, for at least the last 15 years there has been widespread agreement that activist countercyclical fiscal policy is usually not effective in stabilizing the economy. Be that as it may, I don't think that increasing government spending per se can increase total spending. Here is why.
In order to increase its spending, the government must either borrow the money, or print new money. If the government increases its spending by printing money, then its policy is no longer an increase in government spending per se, because the printing of additional money is an act of monetary policy. Hence the only way it can increase its spending as a pure act of fiscal policy is to borrow the money. But if the government borrows the money, then those that lend to government cannot spend the money themselves, nor can they lend it to someone else, who would spend it. First consider someone with $10,000 who plans to spend it himself. The government comes along and decides to borrow another
400 or 500 billion dollars. Is this going to prevent this person from spending his $10,000? If the answer is no not only for this person, but also for the 40 million other people from whom the government would have to borrow $10,000, then the government would not be able to increase its spending unless it does something to persuade these people to change their mind. The only way the government can do this is to being willing to borrow at an interest rate higher than that that currently prevails in the market place. That is, the government can only borrow the 400 to 500 billion dollars in this case by pushing up interest rates enough to persuade spenders to save rather than spend.
But some potential lenders to the governemt, rather than spend the money themselves, would have loaned their money to someone else rather than Uncle Sam. They would have loaned their $10,000 to someone else if Uncle Sam does not come along and borrow it. But the someone else who would have borrowed money surely would have spent the borrowed money. Why else does someone borrow money excpet to spend it? (Possibly to buy a new car, do home repairs, or to invest in a business--but spend it nonetheless.) But if that someone else did intend to spend the money, the government, by borrowing the money itself, prevents that someone else from spending the $10,000. That is, the government's decision to borrow 400 to 500 billion dollars prevents the private sector from spending that money itself. Hence the government cannot increase total spending by an increase in its own spending if those it borrows from (1) would have otherwise spent the money themselves, or (2) would have otherwise loaned the money to someone else.
There is one final possibility, however. This is the possibility that those who would lend the money to Uncle Sam otherwise would have simply held on to the 400 to 500 billion dollars, letting it sit in their bank account or leaving it hidden in mattresses. Is it possible that there is enough money sitting around for this to happen? At the time I am writing this the stock of United States currency held by the public is about $830 billion. (I think that about 40% of this is actually held overseas.) The amount of money held in the form of bank deposits is about $720 billion. So the narrowly defined stock of money is currently a little less than $1,600 billion, with perhaps only about $1,200 held within the United States. This implies that the economy needs about $1,200 billion worth of money narrowly defined to make its normal transactions. If people could make their normal transactions with only $800 billion, then it might be possible to persuade them to lend some of it to the government. But why would Americans hold the money they hold unless they need it to make their normal transactions? Any money not needed for normal transactions can be deposited in bank accounts that pay more interest than currency (which pays none) or the type of checkable deposits that are included in the narrowly defined money stock. Hence, if there is enough money sitting around in bank accounts that people could use to lend to Uncle Sam, it must be in accounts which depository institutions are already using to lend to other borrowers. That is, it is unlikely that there are "idle" holdings of money that the general public would or could use to lend to the government to finance an increase in government spending.
There are macroeconomic models in which increases in government spending cause an increase in total spending. Within the IS-LM model, the model developed by John Hicks, what happens is actually consistent with the above. Within the IS-LM model an increase in government spending financed by borrowing does increase total spending but only because the resulting increases in the rate of interest cause households and business to wish to hold less money--that is, part of the lending to the government comes from the decision of households to hold less money relative to their income. If increases in the rate of interest do not cause people to wish to hold less money, then the increase in government spending will not cause an increase in total spending within the IS-LM model because the LM curve will be vertical.
As a result, it must be concluded that the recently passed stimulus package will not help the United States economy recover from the current recession.
In order to increase its spending, the government must either borrow the money, or print new money. If the government increases its spending by printing money, then its policy is no longer an increase in government spending per se, because the printing of additional money is an act of monetary policy. Hence the only way it can increase its spending as a pure act of fiscal policy is to borrow the money. But if the government borrows the money, then those that lend to government cannot spend the money themselves, nor can they lend it to someone else, who would spend it. First consider someone with $10,000 who plans to spend it himself. The government comes along and decides to borrow another
400 or 500 billion dollars. Is this going to prevent this person from spending his $10,000? If the answer is no not only for this person, but also for the 40 million other people from whom the government would have to borrow $10,000, then the government would not be able to increase its spending unless it does something to persuade these people to change their mind. The only way the government can do this is to being willing to borrow at an interest rate higher than that that currently prevails in the market place. That is, the government can only borrow the 400 to 500 billion dollars in this case by pushing up interest rates enough to persuade spenders to save rather than spend.
But some potential lenders to the governemt, rather than spend the money themselves, would have loaned their money to someone else rather than Uncle Sam. They would have loaned their $10,000 to someone else if Uncle Sam does not come along and borrow it. But the someone else who would have borrowed money surely would have spent the borrowed money. Why else does someone borrow money excpet to spend it? (Possibly to buy a new car, do home repairs, or to invest in a business--but spend it nonetheless.) But if that someone else did intend to spend the money, the government, by borrowing the money itself, prevents that someone else from spending the $10,000. That is, the government's decision to borrow 400 to 500 billion dollars prevents the private sector from spending that money itself. Hence the government cannot increase total spending by an increase in its own spending if those it borrows from (1) would have otherwise spent the money themselves, or (2) would have otherwise loaned the money to someone else.
There is one final possibility, however. This is the possibility that those who would lend the money to Uncle Sam otherwise would have simply held on to the 400 to 500 billion dollars, letting it sit in their bank account or leaving it hidden in mattresses. Is it possible that there is enough money sitting around for this to happen? At the time I am writing this the stock of United States currency held by the public is about $830 billion. (I think that about 40% of this is actually held overseas.) The amount of money held in the form of bank deposits is about $720 billion. So the narrowly defined stock of money is currently a little less than $1,600 billion, with perhaps only about $1,200 held within the United States. This implies that the economy needs about $1,200 billion worth of money narrowly defined to make its normal transactions. If people could make their normal transactions with only $800 billion, then it might be possible to persuade them to lend some of it to the government. But why would Americans hold the money they hold unless they need it to make their normal transactions? Any money not needed for normal transactions can be deposited in bank accounts that pay more interest than currency (which pays none) or the type of checkable deposits that are included in the narrowly defined money stock. Hence, if there is enough money sitting around in bank accounts that people could use to lend to Uncle Sam, it must be in accounts which depository institutions are already using to lend to other borrowers. That is, it is unlikely that there are "idle" holdings of money that the general public would or could use to lend to the government to finance an increase in government spending.
There are macroeconomic models in which increases in government spending cause an increase in total spending. Within the IS-LM model, the model developed by John Hicks, what happens is actually consistent with the above. Within the IS-LM model an increase in government spending financed by borrowing does increase total spending but only because the resulting increases in the rate of interest cause households and business to wish to hold less money--that is, part of the lending to the government comes from the decision of households to hold less money relative to their income. If increases in the rate of interest do not cause people to wish to hold less money, then the increase in government spending will not cause an increase in total spending within the IS-LM model because the LM curve will be vertical.
As a result, it must be concluded that the recently passed stimulus package will not help the United States economy recover from the current recession.
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