I haven't been writing lately here at Rightspeak, simply because I think the atmosphere has taken a turn for the worst. Whether it is the election campaign which is getting closer, or just certain recent contributors who need to grow up, but I don't find this place as good as it was when I first started contributing. There are limits for the things you can say about a candidate and about a fellow contributor, and those have been trespassed several times. Anyway, to the subject...
Deficit spending is good in the short run, even though it may hurt in the long term. That's common knowledge, right?
It's not necessarily true though. It's all about the expectations. Or, in plain terms, it's all about how many people know economics.
Deficit spending causes interest rates to go up. That's basic, since the government is borrowing from the same "pool" of money as private investors. If they want more money, they have to pay higher interest rates. Kind of basic, right? The reason why deficit spending can cause increased growth in the short run is because it takes a while for interest rates to adjust, so there is a gap during that time when spending in the economy can be higher overall.
The problem is, that if consumers know that the interest rates are going to be higher in the future, they are likely to decrease their spending now to brace themselves for this. So government may borrow 100 billlion, and consumers will then immediately start consuming 100 billion less, giving a net effect of absolutely zero - even in the short term. As long as people are gullible and keep on consuming until the interest rate shock actually hits, deficit spending can be give a short-term boost to the economy.
As people become more and more aware about how the economy functions, they will (hopefully) start to do this. And then, stimulus will become even more pointless than it already is.
How far are we to this "breaking point" where enough consumers realize this, so that deficit spending will become pointless? And what happens when it does?
If you think politicians will suddenly stop deficit spending when they see it doesn't have a positive effect on the economy even in the short term anymore, I'm afraid you'll be mistaken. After all, deficit spending finances a lot of pork barrel projects, but also vital things such as medicaid and -care, as well as social security (the budget deficit is now so high that you can't balance the budget without cutting those three, or alternatively cut down on defense).
So how far away are we? The Internet is a perfect way to educate people, in ways that haven't been done before. This popular youtube video with a rap battle between Hayek and Keynes is a perfect example. People are learning more and more about economics and they get to verify for themselves that the laws of economics are true. This certainly speeds up the process.
Yes, I know, most people forget quickly. But some don't. And when enough people do understand the consequences of deficit spending and start to act on that, the consequences will likely shock the economy since most investors don't expect consumers to be that smart (and why should they?). As more and more people understand, the positive effects of deficit spending will decrease. Essentially, what this administration has to do is to keep people ignorant of the real nature of the economy (kind of like they keep telling everyone social security is an insurance).
I'm going to get back on what the US should do to solve the fiscal crisis in another post, I'm afraid it will be pretty academic but I'll try to make myself understood as well as I can.