When the government spends $700 billion, you’ve just increased demand by $700 billion

The other day, my macro-economics professor stated something similar to the title of this post in class. While government spending and demand creation is not directly linear, an interesting point is made.

When the government actually spends, say, $700 billion on roads, bridges, green energy, etc, it injects that money directly into the actual economy. Construction crews, engineers, architects, etc all get hired back on to build things, researchers are brought back into the fold to work on new energy efficient materials and processing methods, etc. Those people now have salaries and will spend at least some of it on “stuff” which will help create jobs at the companies that make “stuff” and so on and so on. Yes, many of these people with new jobs will also save a lot rather than spend but overall you will get new jobs plus more spending which leads to even more jobs.

However, when you give tax cuts, there doesn’t have nearly the demand-creation yield rate (a term I just coined…) as direct injection of money. This is because if, say, 50% of people in this current economic environment will save rather than spend, and 40% of a $700 billion stimulus plan is actually in the form of tax cuts, then we get:

$420 billion directly injected
$140 billion spent from tax cuts

And while $560 billion is a lot of money, the other $140 billion is, too.

Comments (2)

  1. Debbie

    I still don’t like it. Either way, we’re spending (or forgiving, in the form of tax credits) LOADS of money we just don’t have. We already have a record deficit AND debt, and it’s going to get much, much, MUCH worse in the future. People need to feel the pinch – a lot – so they realize how BADLY overstretched they’ve been living, because it’s still a drop in the bucket compared to how overstretched our entire system is. I think we are not nearly out of the woods yet: our entire greatest danger is still a complete collapse of the entire world economic system in a spectacular, never-before-experienced chain reaction.

  2. kaiyen (Post author)

    The macro-economic response is that it doesn’t matter whether people do realize how badly overstretched they were living or not. At least it doesn’t matter right now. We need to implement something to control the labor market and to unlock the credit freeze. Our economy doesn’t work without credit. Long term, yes, we need to prevent non-bank banks from existing (such as Lehman Brothers) and regulate the way loans are made.

    Personally, I wonder whether people will ever realize how badly overstretched they are. At least beyond the next bubble. As soon as the next boom comes around they will forget.

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