Bowyer: Friedman 1: Stimulus 0

Today's data dump from the Bureau of Economic Analysis tells us something very important: Obama's economic stimulus plan has not worked. The Monthly Personal Income and Outlays Report for May, unsurprisingly, reports the monthly personal income and outlay figures for May. It tells us how much we earned (or were given), how much we spent and how much we saved. This is important because a large proportion of the stimulus checks went out this past May. What did we do with them? We saved them. Since the stimulus program was designed to stimulate 'aggregate demand' and not savings, the program has so far been a failure.

Let's take a step back: classical economics focuses on the production of goods and services. It sees the economy as first the arena in which we make things, and afterwards as the arena in which we buy things. Production proceeds consumption in the economy. Keynes tried to invert that order. He saw markets has prone to oversaving and underspending. He labeled this phenomenon 'the paradox of thrift'. For Keynes, recessions and depression came from sudden inexplicable urges to save. The theoretical problems with this are legion, most notably that even saved money gets spent. I save and lend the money to you (typically through an intermediary such as a bank) and then you spend it. So, in the end, all the money gets spent.

Still, since that basic principle remains obvious everywhere but in Washington DC, our planners have decreed a Keynesian solution to our economic doldrums, hence The Stimulus.

Government is taking the money for our overly thrifty wealthy classes and transfer it to workin' people through stimulus checks in order to stimulate spending. But they're not spending, at least not very much. Income last month rose 1.4% but spending only rose 0.3%, the difference was saved. We now have a savings rate just shy of 7% the highest since 1993 when Bill Clinton was openly musing about a big stimulus plan.

In other words, it didn't work.

Milton Friedmanexplained why 40 years ago, in his 'permanent income hypothesis' for which he was given the Nobel Prize. People are not stupid animals. They don't salivate when you ring a bell and they don't just spend when you give them a check. They look ahead into an uncertain future and plan accordingly. They spend not based on the levels of cash currently in the bank, but based on their estimation of their income stream over the foreseeable future net of taxes.

Thank God they do. The policy environment right now is extraordinarily unpredictable. The rational move is to strengthen one's balance sheet, not squirt cash into the shrinking sea of 'aggregate demand'. The reigning formula in Washington holds that government should spend in order to get us to spend. The reigning formula on main street is that when government spends more, we should spend less. Friedman would be pleased.