Friday, November 5, 2010

We often hear that big cuts in government spending over a short time are a bad idea. The case against big cuts, typically made by Keynesian economists, is twofold. First, large cuts in government spending, with no offsetting tax cuts, would lead to a large drop in aggregate demand for goods and services, thus causing a recession or even a depression. Second, with a major shift in demand (fewer government goods and services and more private ones), the economy will experience a wrenching readjustment, during which people will be unemployed and the economy will slow.

Yet, this scenario has already occurred in the United States, and the result was an astonishing boom...

Ask people who lived through that period as young adults what economic conditions were like, and you will inevitably get the answer that they experienced an economic boom. The U.S. economy during the post-World War II years is exhibit A against the Keynesian view that economies will necessarily suffer high unemployment and slow growth when governments make big cuts in government spending. Why did the U.S. economy do so well in the years following World War II given how badly it had done in the years preceding America’s entry into the war? The answer, in a nutshell, is that dramatically reducing government spending and deregulating an economy can take that economy from sickness to health.

-David Henderson at the Mercatus Center
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