The Trouble with Keynesian Stimulus Spending

For more than 70 years, a strand of Keynesian thought has maintained that the cure for economic depressions is merely a matter of simple arithmetic. According to these Keynesians, the government need only increase spending by an amount equal to the ratio of the output gap to the fiscal multiplier. Moreover, these Keynesians assert that even wasteful government spending can be desirable because any spending is better than nothing. This simple Keynesian approach fails to account, however, for several significant sources of cost. In addition to the cost of waste inherent in government spending, financing that spending requires taxation, which entails an excess burden. Furthermore, the employment of even previously idle resources involves opportunity costs. In this paper, we subject Keynesian stimulus spending to a benefit-cost test that accounts for waste, labor disutility, capital consumption, and the excess burden of taxation. We calibrate our model by surveying the published estimates of key parameters, including the Keynesian fiscal multiplier. Our results indicate that stimulus spending can successfully generate net wealth, but generally only if the burden of waste is limited to no more than 20 to 30 percent of the overall size of the spending package.