Keynesianism vs. Pump Priming
By Bryan Caplan
Keynesianism is widely seen as a “pump priming” rationale for government intervention. The government sees the economy in the doldrums, gives it a much-needed jolt, and then the private economy gets back on feet – with no need for further assistance.
If you pay close attention to the simple Keynesian model, though, there’s no pump priming to be found. The model begins with the accounting identity Y = C + I + G. In English, output equals consumption plus investment plus government purchases.
The model then adds a simple consumption function:
C = a + bY, where a>0 and 0<b<1. At low levels of consumption, people consume more than they earn; but when they earn an additional dollar, they consume some but not all of it.
Both I and G, finally, are exogenous. I is whatever the animal spirits make it. G is whatever the government wants it to be. Substituting:
Y = (a + bY) + I + G
Y = (a + I + G)/(1-b)
(1-b) is the infamous “multiplier.” Every dollar of G boosts output by $1/(1-b).
Now take a close look at the final equation. If you need to boost G to get actual output up to potential output, when can you cut G back to normal levels? The answer, in the simple Keynesian model, is never. Boosting G changes consumption, but not the consumption function. And I, as always, is a product of animal spirits – not government policy.
You can naturally fiddle with the simple model to make it work the way you think it should. The simplest fix: Assume investment is an increasing function of past G. The problem is that it’s hard to see why this assumption would be true. It works if the extra G leads to the arrest of the Bolsheviks. Stories relevant to modern economies are harder to tell.
Once your imagination starts running, in fact, it’s easy to see why current I might be a negative function of past G. Maybe higher G signals hostility to business – regime uncertainty, as Higgs puts it. And if the G actually does something useful, it could depress the animal spirits by pre-empting the grand designs of private investors.
Believers in the simple Keynesian model could welcome my conclusion. Perhaps they want a permanent increase in G. Maybe this is what Keynes had in mind when he smiled favorably upon the “socialization of investment.” At the same time, though, the absence of a pump-priming effect limits the appeal of Keynesian remedies. Keynesians can’t honestly say that a temporary relaxation of free-market principles will get the economy firmly back on its feet. Their solution for a sour economy is the permanent expansion of the state – nothing less. And if that’s all they’ve got to offer, most people will probably hold out and hope for a better solution to come along.
P.S. According to Investopedia, “pump priming” is another brain child of… Herbert Hoover:
The phrase originated with President Hoover’s creation of the Reconstruction Finance Corporation (RFC) in 1932, which was designed to make loans to banks
and industry. This was taken one step further by 1933, when President
Roosevelt felt that pump-priming would be the only way for the economy
to recover from the Great Depression. Through the RFC and other public
works organizations, billions of dollars were spent “priming the pump”
to encourage economic growth.