What Happened To The Stimulus? – The Moral vs The Market Economy – by Don Stabile and Andy Kozak


Photo: Austen Hufford, Creative Commons 2.0

In our recent book, Markets, Planning and the Moral Economy: Business Cycles in the Progressive Era and New Deal, we explore the Progressive Era from the perspective of defenders of the Market Economy and advocates for a gentler, kinder Moral Economy.  Throughout the book, but in particular, the chapter on Fiscal Policy, we present the debate between the two camps in terms of the effectiveness of fiscal policy.  A recap of this debate seems appropriate given the current concern over the role of government and the perceived failure of President Obama’s almost trillion dollar stimulus plan and even greater annual deficits. Where did all the stimulus money go?  Why didn’t it work to reduce unemployment and increase GDP more rapidly?  Ideas developed in the Progressive Era may help us understand the answer to these questions.

Upsetting the confidence of the business world

In our book, we note that Keynes, in an open letter to President Roosevelt which appeared in the New York Times, was worried that Roosevelt’s efforts to bring about both recovery from the great depression and the passage of business and social reforms was risking failure.  Keynes argued that it would be better if the New Deal were to focus on bringing about a recovery and use its success in the recovery program to solidify its standing with the public and thereby bolster its chances for true reform.  If reform ‘upset the confidence of the business world’ it would impede the recovery.  Perhaps President Obama’s focusing on passing The Patient Protection and Affordable Care Act upset the ‘confidence of the business world’ and impeded recovery from the ‘great recession.’  Or perhaps this together with Financial Market Reforms and Environmental Regulations is what ‘upset the confidence of the business world.’

Even though Keynes worried about mixing recovery with social reform, as we point out in our book, he was nonetheless very much for dramatic reforms.  Indeed, Keynes argued for social reforms even more dramatic than what President Obama has put forth.  For example, Keynes called for the government to assume the control over investment to ensure it was undertaken for the social good; a moral economy perspective, for sure.   In Keynes’ view, once the government decided where investment should go, the market economy could be relied on to make decentralized decisions on how to use that capital.  The bailing of GM and Fannie and Freddieby the Obama administrationfits this view of a moral economy.  But again, mixing the two goals may have ‘upset the confidence of the business world.’

The multiplier

The effectiveness of fiscal policy as a stimulus also depends upon what economists call ‘the multiplier’.  The point of the multiplier is to show how changes in investment by business or changes in spending by government can generate larger changes in income.  Government spending of any type, Keynes argued, even wasteful spending, would stimulate the economy by giving people money to spend.  When they spent that money on consumption goods, they would, through the multiplier effect, create jobs in the private sector.  In addition, because of the multiplier, the income generated by government spending would increase tax collections, with the result that the budget deficit might not be as large as originally planned.

So why hasn’t President Obama’s stimulus spending worked?  We believe that the words of economist Arthur D. Gayer, written in 1938, provide one answer.  Gayer argued that it was not possible to calculate in advance what the impact of an expansionary fiscal policy would be.  The numerical value of the multiplier could only be calculated after the money was spent and the change in income it generated was known.  The crucial question in the use of an expansionary fiscal policy to fight a recession was, in Gayer’s words:

‘whether its directly beneficial effects in stimulating consumption are outweighed or not by the injurious indirect effects that it may have on private investment through its repercussions on the budget, the bond market, building costs, the state of confidence, and future expectations.’

In other words, the impact of expansionary fiscal policy depends on what economists refer to as the ‘amount of crowding out’. Government spending may crowd out business investment spending by raising interest rates. It may also change the expectations of consumers, businesses and investors.  In Keynes’ words, government spending may ‘upset the confidence of the business world.’

The accelerator

Another economist, J.M. Clark, also offered a perspective that helps explain the poor performance of the recent stimulus plan.  As we note in our book, Clark had investigated investment demand in the 1920s with his theory of ‘the accelerator’. The idea behind the accelerator was that small changes in consumption spending might bring about significant changes in business investment. In 1939, he recognized that government spending might also increase business investment but argued that the total impact of government spending on investment would depend on the attitude businesses took toward that spending. If they believed it would have Keynes’ multiplier effect, that would enhance their expectations about the future and boost investment spending. If not, they would refuse to invest.

The noted Keynesian economist Paul Samuelson also addressed this issue in 1940 and surmised that the efficacy of expansionary fiscal policy depended on the value of the multiplier and its relationship to the accelerator; since these could not be known, policymakers would have to be satisfied that there was a multiplier effect with regard to government spending and hope that it would bring about more investment through the accelerator.

Maybe this time hope was misplaced, no matter how audacious it may have been.


Don Stabile is Professor of the College and Professor of Economics at St. Mary’s College of Maryland. He is the author of 10 books, including The Living Wage: Lessons from the History of Economic Thought, along with numerous research papers and book reviews.  His hobbies include bicycling and following tennis.

Andy Kozak is Associate Professor of Economics at St. Mary’s College of Maryland, where he has served as Chair of the Economics Department and Director of the Nitze Scholars Program. He recently served as a Commissioner for the Local Housing Authority.  His hobbies include anything outdoors and playing basketball.

Markets, Planning and the Moral Economy: Business Cycles in the Progressive Era and New Deal

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