Much is being made of the supposed benefits of medium term deficit reduction through austerity as a reassurance to the private sector to enable them to feel confident enough to spend their several trillion dollar hoard on investing and creating jobs. The problem with this sort of thinking is that it involves a reassertion of a previously discredited doctrine from the 1920s and 1930s called Say’s law and the Treasury view which was central to classical economic orthodoxy during this period.  The British economist John Fender in his very useful book Understanding Keynes:An Analysis of the General Theory put the case rather well back in 1981.

Keynes’s ”concern was with characterizing the theoretical framework underlying their( the classical school) thought. The theory …does generate many of the ideas which one associates with the classical school. For example, if the government increase its spending ,this will lead either to a fall in private sector investment or in consumption or in both, and if consumption spending is interest inelastic there will be 100% crowding-out of the private sector investment- the so called ‘Treasury View’ .( John Fender, Understanding Keynes:An Analysis of the General Theory ,Brighton: Wheatsheaf  books, 1981; p.7)

This is clearly a false doctrine that was discredited in the 1930s but it has once again resurfaced with many Republicans and other fiscal conservatives who are Democrats. There is absolutely no evidence to support this view and in purely logical as opposed to ideological terms it makes no sense. During a crisis and the recession and slow growth period which follows any increased investment or spending benefits aggregate demand which is the key to restoring purchasing power among consumers in order that they will buy what the system is capable of producing. The reason that private sector hoards of cash are not being invested in job creating production has a lot to do with their judgement that consumer demand for the purchase of their output is too weak to justify their expenditure. For ideological reasons some business leaders will complain about government spending and deficits.

They always have and  they always will.

But if a boom in consumption occurs and shows up in the demand for their products they will invest and hire . Otherwise, they are giving up profits they could make. It is because of weakened consumer demand and pessimistic expectations and not government spending or deficits that firms do not spend their cash hoards.

(see also Brad Delong’s blog where he disputes David Harvey’s anti deficit argument.    http://delong.typepad.com/sdj/2009/02/defenders-of-the-treasury-view-part-cxiv-david-harvey-speaks-and-claims-to-know-more-about-keynesian-economics-than-joan.html )