Brian Riedl of the Heritage Foundation has a good Backgrounder on why government spending is no economic stimulus, including answering some of the points that neo-Keynesians make. (Click here for PDF version).
My favorite rhetorical flourish:
The economic models that assert that every $1 of deficit spending grows the economy by $1.50 cannot explain why $1.4 trillion in deficit spending did not create a $2.1 trillion explosion of new economic activity.
Why is this so wrong?
Congress cannot create new purchasing power out of thin air. If it funds new spending with taxes, it is simply redistributing existing purchasing power (while decreasing incentives to produce income and output). If Congress instead borrows the money from domestic investors, those investors will have that much less to invest or to spend in the private economy. If they borrow the money from foreigners, the balance of payments will adjust by equally raising net imports, leaving total demand and output unchanged. Every dollar Congress spends must first come from somewhere else. ..
In fact, large stimulus bills often reduce long-term productivity by transferring resources from the more productive private sector to the less productive government. The government rarely receives good value for the dollars it spends. However, stimulus bills provide politicians with the political justification to grant tax dollars to favored constituencies. By increasing the budget deficit, large stimulus bills eventually contribute to higher interest rates while dropping even more debt on future generations.
Riedl further addresses some of the myths of a stimulus. For instance, the idea that individuals “save” instead of spending money, therefore government spending will grow the economy (Riedl: “But savings do not drop out of the economy. Nearly all people put their savings in: (1) banks, which quickly lend the money to others to spend; (2) investments in stocks and bonds; or (3) personal debt reduction.” And Riedl notes the important concept of the “seen and unseen” – i.e. we see what government monies buys, but not what the money would otherwise have gone towards.