John Cogan and John Taylor have an interesting article in Commentary called Where Did the Stimulus Go? It describes the rationale for the 2008 and 2009 stimulus packages, and explains -in some detail- the reasons why they didn’t work. First, they described the types of Keynesian stimulus packages:
Keynesian stimulus packages come in three basic types. In the first type, the federal government puts money directly into the hands of consumers. The hope is that consumers will use the money to increase their purchases of goods and services. In the second type, the federal government directly purchases goods and services, including infrastructure projects, equipment, software, law enforcement, and education. In the third type, the federal government sends grants to state and local governments in the hope that those governments will use the funds to purchase goods and services.
In each case, according to Keynesian theories, the increase in purchases will stimulate additional economic activity over and above the initial increase in purchases. The 2008 stimulus was mainly of the first type, while the 2009 stimulus was a mix of all three types.
Then, the authors show, with the help of some interesting graphs, what happened. It’s rather lengthy, so I’ll take you right to their conclusion:
To sum up: the federal government borrowed funds that it mainly sent to households and to state and local governments. Only an immaterial amount was used for federal purchases of goods and services. The borrowed funds were mainly used by households and state and local governments to reduce their own borrowing. In effect, the increased net borrowing at the federal level was matched by reduced net borrowing by households and state and local governments.
So there was little if any net stimulus.
Cogan and Taylor add, at the very end, that an analysis and explanation of how Keynesian stimulus doesn’t work was provided by Milton Friedman and Franco Modigliani – in 1957.
Read the entire analysis here.