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Does expansion of public expenditure increase total spending in the economy? Do increases in the budget deficit boost demand and employment? For many people, the answer is a matter of common sense. As Lord Skidelsky observed in a Standpoint Dialogue with me last December, "the surest way to get aggregate spending up is by the government spending the money itself". Skidelsky and others subsequently organised a letter to the Financial Times in February, claiming that "fierce spending cuts" might tip "the economy back into recession".

The claim that changes in the budget deficit, or "fiscal policy" for short, can alter output and employment is often said to originate in John Maynard Keynes's 1936 classic, The General Theory of Employment, Interest and Money. Skidelsky, who has written a magnificent biography of Keynes, and a large number of like-minded commentators revere him as the greatest economist of all time. However, the validity of an idea depends on neither its appeal to common sense nor the sanctity of its author. In our world of scientific method, what matters is consistency with fact. 

Milton Friedman — who died in 2006 aged 94 — is usually seen as Keynes's intellectual antithesis, with his contrasting emphasis on the importance of money and monetary policy to macroeconomic outcomes. 

Friedman derived part of his success from his insistence that theoretical propositions had to be empirically validated. Much of his work was on the topic that Keynes had made so central to public policy, namely the relative effectiveness of fiscal and monetary policy. Friedman's verdict on the historical record was trenchant. 

In January 1996, two British economists, Brian Snowdon and Howard Vane, asked him in an interview, "What role do you see for fiscal policy in a macroeconomic context?" Friedman's reply was curt: "None. One of the things I have tried to to find cases where fiscal policy is going in one direction and monetary policy in the opposite. In every case, the actual course of events follows monetary policy. I have never found a case in which fiscal policy dominated monetary policy and I suggest to you as a test to find a counter-example." Friedman was undoubtedly most interested in US experience and data.

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W. Peden
December 3rd, 2011
12:12 PM
Anonymous, You can have a large increase in employment and unemployment at the same time, if there is a demographic shift towards a larger working population. There was just such a shift in Britain in the 1980s, so it was possible for there to be a lot of new jobs under the Thatcher government AND for unemployment to reach horrific levels.

April 28th, 2011
9:04 AM
"Instead, aggregate demand started to grow within months of the Budget, and the next eight years saw large increases in output and employment." Unemployment increased by 500,000 by 1987. "After a bad recession in the early 1990s, the Major government combined tax increases and spending cuts from 1992 to 1996, and again the economy enjoyed above-trend growth." Caused by leaving the ERM, something Major didn't want to do.

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