The funeral of Keynesian theory

http://www.zerohedge.com/article/eric-sprott-we-are-now-paying-funeral-keynesian-theory

A two percent spending increase inevitably requires an increase in taxes. Due to the nature of interest costs, however, the government would have to raise taxes by MORE than two percent in order to pay back the initial borrowing. According to their data, this increase in taxes would generally lead to a seven percent drop in GDP. As they state in their study: "This shows that when government spending is financed contemporaneously that the contractionary effects of the tax increases outweigh the expansionary effects of the increased expenditure after a very short time."2 Stated simply, ‘borrowing to stimulate’ has never worked as planned because the cost of paying back the borrowed funds surpassed the immediate benefits of the stimulus.

In a follow-on study, Harald Uhlig estimated that an approximate $3.40 of output is lost for every dollar spent on stimulus.3 Another study on the same subject by C’ordoba and Kehoe (2009) went so far as to say that, "massive public interventions in the economy to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a great depression."4

Deficit spending, which has generated smaller and smaller increases in GDP over time, is now generating a negative impact on GDP due to the costs of servicing the debt.

Since Keynesian economics is no longer relevant, some are now arguing that tax cuts will save the day. Two of the academic studies we reviewed suggest that tax relief is a much stronger stimulus to the economy than government spending, and under normal circumstances this is probably true. But we are not in a normal economic environment. Even if the tax cuts implemented by George Bush in 2006 are extended by the next Congress, the US will still face the ‘Keynesian Endpoint’. A Government Accountability Office (GAO) report published in January 2010 states the following: "In our Alternative simulation, which assumes expiring tax provisions are extended through 2020 and revenue is held constant at the 40-year historical average; roughly 93 cents of every dollar of federal revenue will be spent on the major entitlement programs and net interest costs by 2020."12 Extending tax cuts won’t solve anything.

Keynesian stimulus can’t be blamed for all our problems, but it would have been nice if our politicians hadn’t relied on it so blindly. Debt is debt is debt, after all. It doesn’t matter if it’s owed by governments or individuals. It weighs on the institutions that issue too much of it, and the ensuing consequences of paying off the interest costs severely hinders governments’ ability to function properly. It suffices to say that we need a new economic plan – a plan that doesn’t invite governments to print their way out of economic turmoil. Keynesian theory enjoyed a tremendous run, but is now for all intents and purposes dead… and now it’s time to pay for it. Literally.