Can Fiscal Stimulus Revive the US Economy?

It is not possible to lift overall production without the necessary support from final goods and services or from the flow of real funding or the flow of real savings. (For instance, out of the production of ten loaves of bread, if the baker consumes two loaves, his real saving or real funding is eight loaves.)

We have seen that by means of a final consumer good — the bread — the baker was able to fund the expansion of his production structure.

Similarly, other producers must have final, saved, real consumer goods — real savings — to fund the purchase of goods and services they require. Note that the introduction of money doesn’t alter the essence of what funding is. (Money is just a medium of exchange. It is only used to facilitate the flow of goods; it cannot replace the final consumer goods.)

The government as such doesn’t create any real wealth, so how can an increase in government outlays revive the economy?

Various individuals who will be employed by the government will expect compensation for their work. The only way it can pay these individuals is by taxing others who are still generating real wealth. By doing this, the government weakens the wealth-generating process and undermines prospects for economic recovery. (We ignore here borrowings from foreigners.)

The only way fiscal stimulus could “work” is if the flow of real savings (i.e., real funding) is large enough to support (i.e., fund) government activities while still permitting a positive rate of growth in the activities of the private sector. (Note that the overall increase in real economic activity is, in this case, erroneously attributed to the government’s loose fiscal policy.)

If, however, the flow of real savings is not large enough, then, regardless of any increase in government outlays, overall real economic activity cannot be revived.

In this case the more government spends (i.e., the more it takes from wealth generators), the more it weakens prospects for a recovery.

Thus when government, by means of taxes, diverts bread to its own activities, the baker will have less bread at his disposal. Consequently, the baker will not be able to secure the services of the oven maker. As a result, it will not be possible to boost the production of bread, all other things being equal.

As the pace of government spending increases, a situation could emerge where the baker will not have enough bread even to maintain the existing oven. (The baker will not have enough bread to pay for the services of an oven-maintenance technician.) Consequently, his production of bread will actually decline.

Similarly, other wealth generators, as a result of the increase in government outlays, will have less real funding at their disposal. This, in turn, will hamper the production of their goods and services, thereby retarding, not promoting, overall real economic growth.

As one can see, not only does the increase in government outlays not raise overall output by a positive multiple; but, on the contrary, this leads to the weakening in the process of wealth generation in general.