Tag Archives: crowding out

The Fed’s Balance Sheet: What’s the Big Deal?

08 Sunday May 2022

Posted by in Government Failure, Inflation, Monetary Policy

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The Federal Reserve just announced tighter monetary policy in an attempt to reduce inflationary pressures. First, it raised its target range for the federal funds rate (on overnight loans between banks) by 0.5%. The new range is 0.75% – 1%. Second, on June 1, the Fed will begin taking steps to reduce the size of its $9 trillion portfolio of securities. These holdings were acquired during periods of so-called quantitative easing (QE) beginning in 2008, including dramatic expansions in 2020-21. A shorthand reference for this portfolio is simply the Fed’s “balance sheet”. It includes government debt the Fed has purchased as well as privately-issued mortgage-backed securities (MBS).

What Is This Balance Sheet You Speak Of?

Talk of the Fed’s balance sheet seems to mystify lots of people. During the 2008 financial crisis, the Fed began to inject liquidity into the economy by purchasing large amounts of assets to be held on its balance sheet. This was QE. It’s scope was unprecedented and a departure from the Fed’s pre-crisis reliance on interest rate targeting. QE had the effect of increasing bank reserves, which raised the possibility of excessive money supply growth. That’s when the Fed began to pay interest to banks on reserves, so they might be content to simply hold some of the reserves over and above what they are required to hold, rather than using all of that excess to support new loans and deposits (and thus money growth). However, that interest won’t stop banks from lending excess reserves if better opportunities present themselves.

The Fed has talked about reducing, “normalizing”, or “tapering” its balance sheet for some time, but it only recently stopped adding to it. With inflation raging and monetary policy widely viewed as too “dovish”, analysts expected the Fed to stop reinvesting proceeds from maturing securities, which amounts to about $95 billion per month. That would shrink or “taper” the balance sheet at a rate of about $1.1 trillion per year. Last week the Fed decided to cap the “runoff” at $47.5 billion per month for the first three months, deferring the $95 billion pace until September. Monetary policy “hawks” were disappointed by this announcement.

Monetizing Government

So, one might ask, what’s the big deal? Why must the Fed taper its securities holdings? Well, first, the rate of inflation is far above the Fed’s target range, and it’s far above the “average Joe’s” comfort range. Inflation imposes significant costs on the economy and acts as a regressive form of taxation, harming the poor disproportionately. To the extent that the Fed’s huge balance sheet (and the corresponding bank reserves) are supporting incremental money growth and fueling inflation, the balance sheet must be reduced.

In that connection, the Fed’s investment in government debt represents monetized federal debt. That means the Fed is essentially printing money to meet the Treasury’s financing needs. Together with profligate spending by the federal government, nothing could do more to convince investors that government debt will never be repaid via future budget surpluses. This dereliction of the government’s “full faith and credit”, and the open-armed acceptance of the inflation tax as a financing mechanism (à la Modern Monetary Theory), is the key driver of fiscal inflation. Reducing the balance sheet would represent de-monetization, which might help to restore faith in the Fed’s ability to push back against fiscal recklessness.

Buyer of First Resort

Perhaps just as critically, the Fed’s heavy investment in government debt and MBS represents an ongoing distortion to the pricing of financial assets and the allocation of capital. Some call this interference in the “price discovery process”. That’s because the Fed has represented a market-altering presence, a willing and inelastic buyer of government debt and MBS. Given that presence, it’s difficult for buyers and sellers to discern the true values of alternative uses of capital, or to care.

QE was, among other things, a welcome institutional development for the U.S. Treasury and for those who fancy that fresh money printing is an ever-valid form of government payment for scarce resources. The Fed’s involvement also means that other potential buyers of Treasury debt need not worry about interest rate risk, making public debt relatively more attractive than private debt. This is a dimension of the “crowding out” phenomenon, whereby the allocation of capital and flows of real resources between public and private uses are distorted.

The Fed’s presence as a buyer of MBS depresses mortgage rates and makes mortgage lending less risky for lenders and investors. As a result, it encourages an over-investment in housing and escalating home prices. This too distorts the allocation of capital and real resources, at the margin, toward housing and away from uses with greater underlying value.

Conclusion

The magnitude of the Fed’s balance sheet is an ongoing testament to an increasingly dominant role of central authorities in the economy. In this case, the Fed has served as a conduit for the inflation tax. In addition, it has unwittingly facilitated crowding out of private capital investment. The Fed’s purchases of MBS have distorted the incentives (and demand) for residential investment. These are subtle effects that the average citizen might not notice, just as one might not notice the early symptoms of a debilitating disease. The long-term consequences of the Fed’s QE activities, including the inflation tax and distorted allocations of capital, are all too typical of failures of government intervention and attempts at central planning. But don’t expect anyone at the Fed to admit it.

Regulation, Crowding Out, and Malformed Capital

19 Saturday Oct 2019

Posted by in Big Government, Regulation

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Expanding regulation of the private sector is perhaps the most pernicious manifestation of “crowding out”, a euphemism for the displacement of private activity by government activity. The idea that government “crowds out” private action, or that government budget deficits “crowd out” private investment, has been debated for many years: government borrowing competes with private demand to fund investment projects, bidding interest rates and the cost of capital upward, thus reducing business investment, capital intensity, and the economy’s productive capacity. Taxes certainly discourage capital investment as well. That is the traditional fiscal analysis of the problem.

The more fundamental point is that as government competes for resources and absorbs more resources, whether financed by borrowing or taxation, fewer resources remain available for private activity, particularly if government is less price-sensitive than private-sector buyers.

Is It In the Data?

Is crowding out really an issue? Private net fixed investment spending, which represents the dollar value of additions to the physical stock of private capital (and excludes investments that merely replace worn out capital), has declined relative to GDP over many decades, as the first chart below shows. The second chart shows that meanwhile, the share of GDP dedicated to government spending (at all levels) has grown, but with less consistency: it backtracked in the 1990s, rebounded during the early years of the Bush Administration, and jumped significantly during the Great Recession before settling at roughly the highs of the 1980s and early 1990s. The short term fluctuations in both of these series can be described as cyclical, but there is certainly an inverse association in both the short-term fluctuations and the long-term trends in the two charts. That is suggestive but far from dispositive.

Timothy Taylor noted several years ago that the magnitude of crowding out from budget deficits could be substantial, based on a report from the Congressional Budget Office. That is consistent with many of the short-term and long-term co-movements in the charts above, but the explanation may be incomplete.

Regulatory Crowding Out

Regulatory dislocation is not the mechanism traditionally discussed in the context of crowding out, but it probably exacerbates the phenomenon and changes its complexion. To the extent that growth in government is associated with increased regulation, this form of crowding out discourages private capital formation for wholly different reasons than in the traditional analysis. It also encourages malformation — either non-productive or misallocated capital deployment.

I acknowledge that regulation may be necessary in some areas, and it is reasonable to assert that voters demand regulation of certain activities. However, the regulatory state has assumed such huge proportions that it often seems beyond the reach of higher authorities within the executive branch, not to mention other branches of government. Regulations typically grow well beyond their original legislative mandates, and challenges by parties to regulatory actions are handled in a separate judicial system by administrative law judges employed by the very regulatory agencies under challenge!

Measures of regulation and the regulatory burden have generally increased over the years with few interruptions. As a budgetary matter, regulation itself is costly. Robert Higgs says that not only has regulation been expanding for many years, the growth of government spending and regulation have frequently had common drivers, such as major wars, the Great Depression of the 1930s, and the financial crisis and Great Recession of the 2000s. In all of these cases, the size of government ratcheted upward in tandem with major new regulatory programs, but the regulatory programs never seem to ratchet downward.

While government competes with the private sector for financial capital, its regulatory actions reduce the expected rewards associated with private investment projects. In other words, intrusive regulation may reduce the private demand for financial capital. Assuming there is no change in the taxation of suppliers of financing, we have a “coincidence” between an increase in the demand for capital by government and a decrease in the demand for capital by business owing to regulatory intrusions. The impact on interest rates is ambiguous, but the long-run impact on the economy’s growth is negative, as in the traditional case. In addition, there may be a reallocation of the capital remaining available from more regulated to less regulated firms.

The Costs of Regulation

Regulation imposes all sorts of compliance costs on consumers and businesses, infringing on many erstwhile private areas of decision-making. The Mercatus Center, a think tank on regulatory matters based at George Mason University, issued a 2016 report on “The Cumulative Cost of Regulations“, by Bentley Coffey, Patrick A. McLaughlin, and Pietro Peretto. It concluded in part:

“… the effect of government intervention on economic growth is not simply the sum of static costs associated with individual interventions. Instead, the deterrent effect that intervention can have on knowledge growth and accumulation can induce considerable deceleration to an economy’s growth rate. Our results suggest that regulation has been a considerable drag on economic growth in the United States, on the order of 0.8 percentage points per year. Our counterfactual simulation predicts that the economy would have been about 25 percent larger than it was in 2012 if regulations had been frozen at levels observed in 1980. The difference between observed and counterfactually simulated GDP in 2012 is about $4 trillion, or $13,000 per capita.”

In another Mercatus Center post, Tyler Richards discusses the link between declining “business dynamism” and growth in regulation and lobbying activity. Richards measures dynamism by the rate of entry into industries with relatively high profit potential. This is consistent with the notion that regulation diminishes the rewards and demand for private capital, thus crowding out productive investment.

Regulation, Rent Seeking, and Misallocation

Some forms of regulation entail mandates or incentives for more private investment in specific forms of physical capital. Of course, that’s no consolation if those investments happen to be less productive than projects that would have been chosen freely in the pursuit of profit. This often characterizes mandates for alternative energy sources, for example, and mandated investments in worker safety that deliver negligible reductions in workplace injuries. Some forms of regulation attempt to assure a particular rate of return to the regulated firm, but this may encourage non-productive investment by incenting managers to “gold plate” facilities to capture additional cash flows.

Regulations may, of course, benefit the regulated in certain ways, such as burdening weaker competitors. If this makes the economy less competitive by driving weak firms out of existence, surviving firms may have less incentive to invest in their physical capital. But far worse is the incentive created by the regulatory state to invest in political and administrative influence. That’s the thrust of an essay by Wayne Brough in Real Clear Markets: “Political Entrepreneurs Are Crowding Out the Entrepreneurs“. The possibility of garnering regulations favorable to a firm reinforces  the destructive focus on zero-sum outcomes, as I’ve gone to pains to point out on this blog.

Crowding out takes still other forms: the growth of the welfare state and regulatory burdens tend to displace private institutions traditionally seeking to improve the lives of the poor and disenfranchised. It also disrupts incentives to work and to seek help through those private aid organizations. That is a subject addressed by James Whitford in “Crowding Out Compassion“.

Just Stop It!

President Trump has made some progress in slowing the regulatory trend. One example of the Administration’s efforts is the two-year-old Trump executive order demanding that two regulatory rules be eliminated for each new rule. Thus far, many of the discarded regulations had become obsolete for one reason or another, so this is a clean-up long overdue. Other inventive efforts at reform include moving certain agency offices out of the Washington DC area to locales more central to their “constituencies”, which inevitably would mean attrition from the ranks of agency employees and with any luck, less rule-making. The judicial branch may also play a role in defanging the bureaucracy, like this case involving the Consumer Financial Protection Bureau now before the Supreme Court. Unfortunately, tariffs represent taxation of consumers and firms who use foreign goods as inputs, so Trump’s actions on the regulatory front aren’t all positive.

Conclusion

The traditional macroeconomic view of crowding out involves competition for funds between government and private borrowers, higher borrowing costs, and reduced private investment in productive capital. The phenomenon can be couched more broadly in terms of competition for a wide variety of goods and services, including labor, leaving less available for private production and consumption. The growth of the regulatory state provides another piece of the crowding-out puzzle. Regulation imposes significant costs on private parties, including small businesses that can ill-afford compliance. The web of rules and reporting requirements can destroy the return on private capital investment. To the extent that regulation reduces the demand for financing, interest rates might not come under much upward pressure, as the traditional view would hold. But either way, it’s bad news, especially when the regulatory state seems increasingly unaccountable to the normal checks and balances enshrined in our Constitution.

Deficits Are a Symptom of Statist Excess

12 Monday Feb 2018

Posted by in Big Government, Taxes

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One thing’s clear with respect to President Trump’s budget proposal and the ongoing debate over appropriations: federal spending will increase and add to future budget deficits. This follows the Tax Cuts and Jobs Act (TCJA) enacted late last year, which many expect to add upwards of $1 trillion to deficits over the next 10 years. I have offered mixed praise of some of the reforms and rate cuts in the TCJA, though it does not accomplish much in the way of tax simplification and it will almost certainly require a large increase in federal borrowing. Ultimately, however, dollar for dollar, a tax cut giving rise to a deficit inflicts lower (or even negative) costs on the private sector than an unfunded spending binge, which is costly in the most basic terms: resources devoured by government.

Cost of Spending

The cost of an extra dollar of government spending at the most basic level is the value of lost opportunities to which the resources absorbed by government otherwise could have been put. When the government spends an extra dollar, and if the government pays a competitive market price, the goods and services exchanged for that dollar by private party “A” would be valued at more than one dollar by other private parties who lost the opportunity to trade with “A” for those same goods and services.

There might be a strong case for incremental spending in any particular instance, of course. Can we benefit from more national defense? Infrastructure? Grants of foreign aid? Subsidies for this industry or that? This technology or that? This cultural program or that? Public aid? Primary research? Regulatory budgets? I’d favor very few of those as general spending priorities. However, there are many subcategories and so many special interests that it is difficult to control spending as long as compromise is needed to accomplish anything.

The Trump budget is a mix of cuts in non-defense spending and large increases in defense, infrastructure outlays, and border security. On balance, it would lead to substantially higher budget deficits over the next ten years. He won’t get all of what he wants, but it would be astonishing if larger deficits are not an outcome.

Unfortunately, government is typically inefficient in the execution of its tasks and it is less responsive to price incentives than private buyers, who are fully vested in “ownership” of the dollars they spend. Government agents, no matter how honorable, simply do not have the same kind of stake in the outcome as a private owner. Obviously, spending by federal agencies is influenced by the political process, which creates opportunities for side rewards for those who direct or influence spending and those who receive the payments. These side rewards are pure private rents arising from public largess. For a private party, the profitability of transacting with government may well exceed the normal return to capital or entrepreneurship. The efficiency of government spending is compromised by its political nature and the uneconomic behavior of government agents. I therefore have strong doubts about the cost-benefit comparison of almost any public initiative.

Un-Taxing

The government ultimately acquires its funds from taxes enforced via coercive power. After all, tax collection requires a considerable enforcement effort. A tax payment of one dollar requires the sacrifice of things that would have been acquired, now or in the future, in voluntary, private transactions valued more highly than one dollar by the taxpayer. That is the nature of gains from voluntary trade foregone. The result is that one dollar of taxation extracts more than one dollar of value from the private sector. Conversely, a reduced tax liability of one dollar means that private parties can engage in an extra dollar of voluntary trade and benefit from the surplus.

There are few forms of taxes that don’t distort incentives in the private market. Taxes may blunt incentives for work, saving, and deployment of capital in productive uses. To the extent that these private decisions are twisted by taxes in ways that differ from fully voluntary decisions, there is a further loss of value and resource waste. Eliminating these distortions is always a worthy goal.

Funding Deficits

Government has ways other than immediate taxation of paying for excess spending. One is to borrow from the public, domestic or foreign. Those who purchase the government’s debt, loaning their money to the government, do so voluntarily. That debt carries an interest obligation by the government, and it must repay the principle some day. That will require new taxes and their attendant distortions, even more borrowing, and/or some other method of extracting value from the private sector. A principle known as Ricardian equivalence holds that the effects of government outlays are the same whether financed by taxes or borrowing, because taxpayers know that future taxes will be owed to pay off government debt, and so they discount that liability into their behavioral calculus.

Additional borrowing can create an unstable financial environment if borrowing occurs at interest rates higher than the economy’s rate of growth. Borrowing might also “crowd out” private borrowers, absorbing saving that would otherwise be used to finance investment in the economy’s productive capacity. In other words, the resources acquired with that extra dollar of government spending will lead to less private investment and a sacrifice of future production.

Sneaky Inflation Tax

Another way that government can pay for spending is by imposing an inflation tax. This amounts to a devaluation of privately-held assets accomplished by inducing unexpected inflation. It allows government debt to be extinguished in the future with dollars having reduced purchasing power. Essentially, more currency (or its electronic equivalent) is placed into circulation: money printing, if you like. That sets up the “too-much-money-chasing-too-few-goods” inflation cycle. But like any other tax, the inflation tax is involuntary and creates waste by inducing the public to respond to distorted incentives.

Summary

An additional dollar of government spending absorbs a dollar of resources, and destroys more value than that given lost surplus to those who would otherwise have benefited from those resources. Moreover, the spending often fails to return a full dollar in benefits, often lining the pockets of elite grifters in the process. Ultimately, the funding for incremental spending must be commandeered from private parties via taxes or an inflationary taking of assets. Public borrowing might conceal the reality of taxes for a time, but it may crowd out productive investment that would otherwise enhance economic growth. So a case against incrementally larger government can be made in terms of resource costs as well as the distortionary effects of taxes and dissipation of future private growth.

By the same token, an ostensible reduction in taxes might be illusory, to the extent that future taxes or an inflationary taking will be necessary to cover the debt one day. On the other hand, there is no direct resource cost involved, and a tax reduction unbinds constraints and distortions on private incentives, which is unambiguously beneficial. And that’s true as long as the tax reductions aren’t targeted to benefit particular sectors, parties or technologies in any new misadventures in government central planning.

Deficits, in and of themselves, are either irrelevant or possibly damaging to long-term economic growth. You’ll get them with either tax cuts or spending hikes. But spending hikes absorb real resources, whereas tax cuts release resources by transforming a dead weight loss in private markets into proper gains from trade. If deficits are a problem, and if eliminating them requires costly tax distortions, then the real problem is the expanse of the state.

Stimulus and The Infrastructural Itch

06 Friday Feb 2015

Posted by in infrastructure

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Politicians may be rightly convinced that to utter the phrase “investment in infrastructure” is to goose the dopamine levels of voters and political reporters. It is an hypnotic mantra, especially if it can be paired with “economic stimulus”. And it seemingly matters not whether the benefits of an actual project exceed costs. The time-lines involved in infrastructure investment, legislative, planning, and construction, almost guarantee an absence of political accountability for projects that end badly.

Apparently, it doesn’t even matter whether an infrastructure project actually gets underway. President Obama knows that the promised spending can go to any pet initiative. This is driven home in “Infrastructure Bait and Switch” by Warren Meyer. He distinguishes between two types of this “B&S”:

“The first time around [Obama] sold the stimulus bill as mainly an infrastructure spending bill — remember all that talk of shovel-ready projects? Only a trivial percentage of that bill was infrastructure. At most 6% was infrastructure, and in practice a lot less since Obama admitted later there were no shovel-ready projects. … The rest of it was mainly stuff like salary support for state government officials. Do you think he would have as easily sold the ‘wage support for state government officials’ bill in the depth of a recession? No way, so he called it, falsely, an infrastructure bill.

The other bait and switch that occurs is within the infrastructure category. We have seen this at the state level in AZ several times. Politicians love light rail, for some reason I do not understand, perhaps because it increases their personal power in a way that individual driving does not. Anyway, they always want money for light rail projects, but bills to fund light rail almost always fail. So they tack on a few highway projects, that people really want, call it a highway bill and pass it that way. But it turns out most of the money is for non-highway stuff.”

Meyer links to this post in support of his “6%-was-infrastructure” claim, and he is right.

Holman Jenkins makes the same basic point in “The Infrastructure Medicine Show“, noting that the temptation to misallocate resources into boondoggles is made worse by the perception that “free money” is available by virtue of the Federal Reserves’s zero interest rates policy:

“In the U.S., why does top-down infrastructure enthusiasm always seem to turn to California-style bullet trains—i.e., projects certain to lose money but beloved by politicians and pork-barreling interest groups?”

I disagree with Jenkins’ assertion that public infrastructure investment should only follow economic growth. Rather, it should occur on an ongoing basis to meet important needs as they arise, and the threshold for any project’s benefits should match the opportunity cost of private capital investment. To some approximation, this might help protect against crowding out of the sort decried by John Cochrane.

The supposed infrastructure crisis, so often invoked by politicians, appeals to any motorist who has ever encountered a pothole. But in terms of basic transportation infrastructure, the “crisis” is something of a myth. In fact, if the widely anticipated revolution in autonomous vehicles transpires, it will greatly diminish needs for expanded transportation infrastructure of all kinds.

President Obama touts infrastructure investment in his new budget proposal using the Keynesian language of economic stimulus. But in another interesting post, Warren Meyer points out that a proposal to run budget deficits of $500+ billion going forward, in the middle of an economic expansion, is not exactly sensible as countercyclical fiscal policy. When might the U.S. government run a budget surplus? In a mild fit of sarcasm, Meyer highlights an irony:

“While those evil private short-term-focused private actors have used the improving economy to de-leverage back below 2007 levels, governments have increased their debt as a percentage of GDP by just over 50% since just before the last recession.”

P.S.: Jerry Brown wasn’t the focus here, but I love the cartoon above. It’s a nice depiction of the boondoggling impulse common to so many politicians.

Strangling By Stimulus

01 Sunday Feb 2015

Posted by in Government

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Will more government spending fix a weak economy? That is certainly a common refrain heard from economists and other pundits, including prominent members of the private business community. The historical record suggests otherwise, however, and there are practical reasons to doubt the efficacy of this sort of “fiscal stimulus.” Some of these are explored in “‘Timely, Targeted and Temporary?’ An Analysis of Government Expansions Over the Past Century“, from the Mercatus Center. In particular, countercyclical spending efforts have violated the “three Ts” often said to be required for successful demand-side policies. These efforts have been systematically late, badly targeted, and have resulted in permanent expansions in the resources absorbed by the government sector.

“Fiscal stimulus efforts going back to the 1930s consistently fail to meet the three Ts objective:

  • Improper timing. Policymakers have consistently struggled to properly time fiscal stimulus spending. In every postwar recession in the 20th century where stimulus spending was attempted, government spending peaked well after the economy was already in recovery. Policy lags—recognition, decision-making, implementation, and impact—are largely responsible for this fact.
  • Inefficient targeting. Going back to the New Deal, policymakers have targeted stimulus funds on the basis of politics rather than what delivers the most bang for the taxpayer buck. Further, individual policymakers cannot possess all the collective knowledge required to allocate and direct economic resources in the most efficient and effective manner, as markets do.
  • Permanent expansion of government. Stimulus funding has almost always led to permanent expansion in the size and scope of government. Indeed, the alleged need for immediate stimulus opens the door for expansions in government that might not have occurred under normal circumstances. On the rare occasions that the increased spending has been temporary, the costs have generally outweighed the benefits.“

As for inefficient targeting, I often hear that our nation’s infrastructural needs clinch the argument for stimulus spending. But those needs should be the focus of long-term planning and addressed on a continuing basis, not in bursts dictated by the state of the business cycle. Good projects should not be neglected in good times or bad, and there is no justification for undertaking a project if is not worthwhile on its merits. If increased spending can stabilize a weak economy, government should simply do something it does well: write checks. Who does infrastructure spending  help in those bad times? It certainly fails to address the basic human needs left unmet in a weak economic environment; it may or may not add high-paying construction jobs. (An aside: in the last recession, the stimulus program didn’t so much add construction jobs as it did accelerate certain “shovel-ready” projects.)

Proponents of government stimulus always have a culprit in mind for the economy’s ills: weak demand or under-consumption. They say government can lead the way out with more spending. This post on Sacred Cow Chips, “Keynesian Bull Chips“, disputes this point of view and provides some links on the topic, including this post by John Cochrane that is now ungated on his blog. Stimulus efforts are usually billed as temporary but rarely are. The expanded budgets always seem to remain expanded, and government absorbs an increasing share of the nation’s spending. Meanwhile, the value of government’s contribution to output is overstated, since most of the output is not subject to a market test or valuation.

The growth of government increasingly burdens private sector. Apart from tax distortions, the resources available to the private sector are gradually crowded and squeezed by the growth of public spending. Private investment is curtailed as government deficits absorb a growing share of private saving. Increasingly detailed regulation diminishes the private sector’s productivity. Robert Higgs at the Mises Institute asks: “How Much Longer Can the U.S. Economy Bear the Burdens?” That’s a very good question.

The opposite of expansionary fiscal policy is fiscal austerity: lower spending, and lower deficits. The budget sequester, originally passed in 2011, is a good example. Keynesians typically contend that austerity will weaken the economy, but the evidence often suggests the contrary. Here is a Scott Sumner post on that point. For robust economic growth, cut spending broadly, cut taxes, and deregulate.

Fractured Fiscal Fairy Tales: Moot Multipliers

03 Wednesday Sep 2014

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Scott Grannis asserts that the multiplier associated with fiscal stimulus is roughly zero, and evidence over the past few years suggests that he may be right. He appeals to a form of the classic “crowding out” argument: that debt-financed increases in government spending absorb private saving, leaving less funding available for private capital investment. In the present case, federal deficits ($7.4 trillion since 2009) have soaked up more than 80% of the corporate profits generated over that time frame. Profits are a major source of funds for private capital projects, risky alternatives against which the U.S. Treasury competes.

There are other reasons to doubt the ability of fiscal policy to offset fluctuations in economic activity. Transfers, which have grown dramatically as a percentage of federal spending, can create negative work incentives, thereby diminishing the supply of labor and adding cost to new investment. The growth of the regulatory state adds risk to privately invested capital as well as hiring. Government projects also offer tremendous opportunities for graft and corruption, at the same time diverting resources into uses of questionable productivity (corn, solar and wind subsidies are good examples). Many federal programs in areas such as education fail basic tests of success. Federal bailouts tend to prop up unproductive enterprises, including the misbegotten cash-for-clunker initiative. Even government infrastructure projects, heralded as great enhancers of American productivity, are often subject to lengthy delays and cost overruns due to regulatory and environmental rules. Is there any such thing as a federal “shovel-ready” infrastructure project?

In recent years, research has found that spending multipliers are small and often negative in the long run, contrary to what statists and old-time adherents of Keynes would have you believe. Empirical multipliers tend to be smaller in more open economies and under more flexible exchange rate regimes. Of growing importance to many developed economies, however, is that spending multipliers tend to be zero or even negative in the long run when government debt is high relative to GDP. This is broadly consistent with the classic crowding-out explanation for low multipliers, whereby public debt burdens absorb private saving. U.S. government debt-to-GDP is now well above 60%, an empirical point of demarcation separating high and low-multiplier countries. Finally, some economists believe that fiscal stimulus is frequently offset by countervailing monetary tightening under an implicit policy of nominal GDP targeting. Scott Sumner describes this as the story of the past few years, as neither the fiscal expansion of the 2009 stimulus plan nor the contraction of the fiscal cliff and sequestration had much if any observable impact on economic growth.

Politicians, the mainstream press and eager Keynesian economists are seemingly always ready to pitch fiscal policy and higher federal spending as the solution to any macroeconomic problem. Sadly, that is unlikely to end any time soon, because the story they tell is so simple and tempting, and they are blind its insidious nature.