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By Root 829 0

could stimulate aggregate demand turns out to be one that works in limited conditions only, making it more of a special theory than the general theory he had claimed. Stimulus programs work better in the short run than the long run. Stimulus works better in a liquidity crisis than a solvency crisis, and better in a mild recession than a severe one. Stimulus also works better for economies that have entered recessions with relatively low debt levels at the outset. The seminal yet still underappreciated econometric work of Professor Carl F. Christ from the 1960s theorized that both Keynesian and monetarist tools work most powerfully for economies that have started with a balanced budget. Christ was the first to identify what he called the “government budget restraint,” a concept that seems to have been forgotten in the meantime. Christ wrote, “Results suggest forcefully that both the extreme fiscal advocates and the extreme monetary advocates are wrong: Fiscal variables strongly influence the effect of a given change in the . . . money stock, and open market operations strongly influence the effects of given changes in government expenditures and taxation.” Christ was saying that the impact of Keynesian stimulus could not be gauged independently of the deficit starting line.

None of the favorable conditions for Keynesian stimulus was present in the United States in early 2009. The country was heavily burdened with debt, was running huge deficits and was suffering from a severe solvency crisis that promised to continue for many years—exactly the wrong environment for Keynesian stimulus. The stimulus spending would increase the deficit and waste valuable resources, but not do much else.

Two years after the Romer and Bernstein study, the economic results were in, and they were devastating to their thesis. Romer and Bernstein had estimated total employment at over 137 million by the end of 2010. The actual number was only about 130 million. They had estimated GDP would increase 3.7 percent by late 2010; however, it had barely increased at all. They had also estimated that recession unemployment would peak at 8 percent; unfortunately, it peaked at 10.1 percent in October 2009. By every measure the economy performed markedly worse than Romer and Bernstein had anticipated using their version of the Keynesian multiplier. From the start, the Obama stimulus was little more than an ideological wish list of favored programs and constituencies dressed up in the academic robes of John Maynard Keynes.

The Romer-Bernstein plan almost certainly saved some jobs in the unionized government sector. However, few had argued that the stimulus would produce no jobs, merely that the hidden costs were too high. The combination of deficit spending, monetary ease and bank bailouts had boosted the economy in the short run. The problem was that the recovery was artificial and not self-sustaining, because it had been induced by government spending and easy money rather than by private sector consumption and investment. This led to a political backlash against further deficit spending and quantitative easing.

The increased debt from the failed Keynesian stimulus became a cause célèbre in the currency wars. These wars were primarily about devaluing a country’s currency, which is a form of default. A country defaults to its foreign creditors when its claims suddenly become worth less through devaluation. A country defaults to its own people through inflation and higher prices for imported goods. With debt in the hands of foreign investors reaching unprecedented levels, the international impact of devaluation was that much greater, so the currency wars would be fought that much harder.

Because debt and deficits are now so large, the United States has run out of dry powder. If the United States were struck by another financial crisis or a natural disaster of the magnitude of Hurricane Katrina or greater, its ability to resort to deficit spending would be impaired. If the United States were confronted with a major war in the Middle East or East Asia, it