Can You Spend Your Way Out of Recession?

“You can’t spend your way out of recession” is a sound bite heard almost every day on financial TV. Recently a guest commentator combined that sound bite with this one: “You can’t borrow your way out of debt.” Perhaps the second one was intended to divert our attention from the first one. Clever. Perhaps too clever by half.

Of course you can spend your way out of recession, almost by definition. A recession can be defined as a shrinkage of spending and income. More spending is needed to generate more income. Therefore, more spending will do the job.

I think the problem is that spending your way out of a recession is the message of Keynes’s “General Theory of Employment Interest and Money, and people don’t want to be labeled a “Keynesian.” But surely one can cling to his classical economic principles while acknowledging that Keynes had a point, especially during recessions.

In a recession, income declines because spending declines, and spending declines because income declines. It’s a vicious circle that needs to be broken. One option might be tax cuts to increase business spending. Another might be lower interest rates to stimulate spending. Another is to have government spending make up the slack. That will work if it has monetary policy support, i.e. if the government spends newly created money so it doesn’t crowd out private spending.

I don’t necessarily want to be labeled a Keynesian either, but I see no reason to fear acknowledging that he had a point. To say that we can’t spend our way out of a  recession may make a good sound bite, but it has no credibility.

Comments (5)

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  1. Poulette says:

    The problem is that “spending out of a recession” often assumes/insinuates that it is merely CONSUMER spending, rather than including the producer sector spending on capital investments. It also is conflated with the necessity to increase DEMAND and paying no attention to a paucity of SUPPLY.

    Therefore, if by “you can spend your way out of a recession” means that consumers should simply open their wallets and start shelling out for things, I would counter that it’s false. If on the other hand, you mean that we need to continue to invest and build, and by this you also mean that banks should continue to lend in order that we might accomplish this, then yes, I would agree.

  2. Wally the K says:

    Bob, was this blog somewhat tongue in cheek? The pundits of course are talking about endlessly stimulating consumer spending which is a one way trip over the financial cliff.

    I’m reminded of an early life lesson when an aunt gave us a bag of nickels and said go play my slot machine. At the end of the day you can keep your winnings (there were none, of course). This story is my favorite way of explaining the inevitable outcome of the present government stimulus plans- when the last nickel is squandered, and unemployment is still 17%, then what? Try another bag of nickels?

    Eventually, when all the Keynesian (Krugman) ideas have been tried and re-tried and failed, some timid soul will meekly propose to give small business a huge tax break-like no income or FICA taxes for 5 years- which will finally power a massive job recovery in America.

    Joe the plumber will buy the business, hire as many people as he can to maximize profits, reward himself with a new house, a new car, new furniture, and take his wife out to a show and nice dinner.

  3. Bob McTeer says:

    Response to Poulette and Wally the K;

    It was only partially tongue in cheek–the shock value of answering yes. I don’t think the blanket statement that “you can’t spend your way out of recession” holds up. You have to put your Keynesian hat on for a while. After all The General Theory is special-case economics on spending your way out of recession.

    In a recession there is too little spending to generate enough income for full employment. The problem is the chicken and the egg. You need more income to spend more and you need more spending to raise income. You might break that cycle through tax cuts to raise disposable income or to incentivize more investment spending. That is preferable. However, government spending can get the ball rolling again. As government spending raises incomes, there will be multiplier effects. More consumer spending will lead to more business spending, etc. So as a technical matter you can spend your way out of recession.

    Government spending isn’t the best way, and the stimulus bill was atrocious, but I was talking about the logic of the proposition. Also, I’m not taking about standards of living; just spending which generates income. Digging holes and filling them up would work. Theoretically government pump-priming need not lead to permanently larger government, although it may and usually does in practice.

    Regarding ignoring supply, just as Say said supply creates its own demand, Keynes’ point was that demand can create it own supply. They’re not mutually exclusive.

  4. Gamaliel Isaac says:

    All we gotta do is spend and we’ll be rich. Why didn’t I think of that. I guess I’m too rational.

  5. Mike Biddell says:

    Bob is completely right….. it’s not tongue in cheek. You do not “save” your way out of a recession. There is no paucity of supply, that’s complete cobblers…..people trot out the platitude of supply and demand…. in a modern roboticised society, in my experience, prices go down as demand goes up. Money is an artificial invention. I am in favour of every country printing its own GDP in currency. Since everyone does it, there would be no reason to devalue/change relative currency parity.