Yesterday Gov. Perdue issued an executive order extending unemployment benefits in North Carolina. According to a statement released by her office the benefits will impact roughly 25,000 out of work North Carolinians, and will be financed exclusively with federal money. It is understood that these funds are not being loaned to NC by the federal government, so the $2.6 billion that we already owe the feds for previous unemployment benefits will not be added to.
Of course, the Governor's statement does not mention the fact that the federal government is so deep in the hole financially that they will likely have to add to the massive national debt to cover the extended unemployment benefits.
Furthermore, part of the Governor's statement underscored the economic ignorance of so many of the political class:
In addition to providing desperately needed financial help to the families that actually receive the benefits, these federal dollars will help all North Carolinians because the money will circulate throughout the economy and help support large and small businesses across the state.
The underlying premise of the "unemployment benefits will boost the economy because the recipients will spend it" lies in the belief that economic recovery requires a boost in "aggregate demand". The most simple way to boost aggregate demand, according to many, is to raise consumer spending.
But as I have noted several times in the past, consumer spending does not drive the economy and is not the cause of recessions. In fact, as noted here, consumer spending is now back up above pre-recession highs.
The oversimplified and misguided notion that just having people buy more stuff will spur economic recovery is a common fallacy held for generations. Economic recovery, in large part, requires a replenishment of capital – a major source of capital investment is savings. So when the government borrows money, it removes savings from the economy and transfers it to unemployment benefits that are spent on consumption. This transfers more economic activity from capital investment to simply using stuff up (consumption).
Without the resources necessary to replenish capital goods, and with factors such as regime uncertainty holding entrepreneurs back from expanding their productive capacity, the increase in consumer spending (via extended unemployment benefits) without a corollary increase in the output of goods translates into more consumer dollars chasing a relativeley fixed output of goods. The result is price inflation.
Price inflation is typically felt first in food and energy prices – price increases that hurt poor and low income people the hardest.
Moreover, extending unemployment benefits alters the decisions of the unemployed, encouraging them to hold out longer for the "right" job or to demand higher wages. This makes it more difficult and more expensive for those large and small business in NC Perdue claims will be helped to hire more workers. This helps keep unemployment up and production down – further exacerbating the problems outlined above.