Tuesday, March 8, 2011

Unprovable counterfactuals

Economic policy over the last two years was one huge Keynesian experiment. The fiscal deficit was pumped up, allegedly to prevent an apocalyptic depression. Can we see any evidence that this massive fiscal expansion had any practical impact on economic growth? In a word, no.

Despite this historically unprecedented policy intervention, real GDP collapsed in 2008. For six straight quarters, the economy contracted. There was a modest and decidedly anaemic recovery last year. Nevertheless, the economy remains about 4.5 percent smaller compared to its previous peak.

Nevertheless, there is the unobservable counterfactual. Deficit junkies argue that while it is true that the economy contracted as the fiscal deficit exploded, the contraction would have been even greater if the government had not tried to support demand.

It is an unprovable claim. Nevertheless, it remains a durable one. There are few economists who are prepared to come forward and admit that the Keynesian experiment was a disaster. It did nothing for growth and bequeathed a massive debt stock that will impoverish future generations for decades.

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