Dec. 18 (Bloomberg) -- More than 70 years after the ideas of a British economist were used to justify a huge expansion in the government’s role in the economy, John Maynard Keynes is back.

Almost everyone today agrees that a big fiscal stimulus is just what the doctor ordered to lift the U.S. economy out of what is fast becoming the worst slump since the Great Depression. (The few remaining limited-government types are hunkered down at Washington’s Cato Institute.) The only questions for the Obama administration are the size of the package (anywhere from $500 billion to $1 trillion) and its composition (infrastructure, tax cuts, transfers to the states, “green” jobs).

That the idea of government spending substituting for private demand is still kicking around after all this time makes you wonder just what kind of a science economics is. Why don’t we know with some degree of certainty whether old-fashioned pump- priming works? Do we care? Or is this about government appearing to “do something” -- anything -- in a crisis?

The medical profession conducts double-blind studies to determine the efficacy of a new drug compared with a placebo. In economics, simulations substitute for reality.

And for good reason. It’s impossible to hold everything else constant in the real world so that the specific effect of any stimulus can be isolated and evaluated. We don’t know how the economy would have performed absent government spending programs, or to what degree an improvement in the economy is attributable to something other than fiscal policy: monetary policy, for example.

Dismal Scientists

That said, practitioners of the dismal science always have facts and figures at the ready to justify new government spending. Mark Zandi, chief economist at Moody’s Economy.com, assessed the impact of a $600 billion fiscal stimulus package, ranking various tax cuts and spending initiatives on their “bang for the buck.”

Every dollar spent on food stamps and unemployment benefits yields a one-year increase in gross domestic product of $1.73 and $1.63, respectively, Zandi says. Recipients of government transfer payments “are hard-pressed and will spend any financial aid they receive very quickly,” he says.

And that’s exactly what members of Congress aim to do: Put money in the pockets of people who will spend it. Keynesian theory -- the idea that the government can stimulate economic activity and reduce unemployment -- provides the philosophical justification for spending other people’s money.

Borrow, Tax, Print

There’s only one problem with the theory: a “glaring logical fallacy,” says Dan Mitchell, senior fellow at the Cato Institute, a libertarian think tank. “In the real world, government can’t inject money into the economy without first taking money out of the economy,” he says. “The theory only looks at one-half of the equation.”

The government can only spend if it borrows or taxes. Neither produces an increase in “aggregate demand,” Mitchell says. “The pie is sliced differently, but it’s not any bigger.”

“If the government finances its spending by raising taxes, it transfers spending power from one group to another,” says Paul Kasriel, director of economic research at the Northern Trust Corp. in Chicago. “If the government finances its spending by selling bonds, it transfers spending power from one entity to another.”

Get ready for the “but.”

“But if the government finances its spending by printing money, then no other group is induced to cut back on its spending, and there is a net increase in nominal spending,” Kasriel says.

Born to Print

If the Federal Reserve’s decision to cut its benchmark overnight rate to a range of 0 percent to 0.25 percent this week and its stated intention to use “all available tools” to keep its “balance sheet at a high level” are any guide, the Fed will be “monetizing the debt,” which is how we in the developed world refer to the crass act of printing money.

And we even use a two-step process to keep it above board. The Fed isn’t authorized to buy government securities directly from the Treasury, which is how it’s done in banana republics. Here, the Treasury borrows from the public (sells bills, notes and bonds), and the Fed then buys Treasuries from that same public, with even a small cut for the middleman!

The whirring sound of the printing press is hard to ignore. The Fed’s balance sheet, or the credit created by the Fed, was “equal to the amount of borrowing by the domestic non-financial sector in the third quarter of 2008 on a seasonally adjusted basis,” Kasriel says. The Fed usually creates “the seed money, with the banking system doing the rest.”

Into Thin Air

This time around, the central bank created “out of thin air” the entire amount, which is “unprecedented in the post-war period,” he says. “It may be unprecedented in the history of the Fed, but I don’t have data going back that far.”

When the history of this crisis is written, the Fed’s role (monetizing the debt) will probably get lost amid the hosannas for fiscal stimulus. Both Democrats and Republicans, who seem to have adopted big government as their own, are on board. Rare is the voice that objects to committing vast sums of money for a theory I thought was as dead as Keynes in the long run.

“It’s very lonely,” Cato’s Mitchell admits. “We’re thinking of running an ad on E-Harmony: Seeking small-government conservatives.”

Or better yet: “Single white think tank seeks Ayn Rand-type looking to share romantic dinners, walks along the beach and entrepreneurial business ventures. Must be comfortable living in philosophical exile.”

(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Caroline Baum in New York at cabaum@bloomberg.net.

Last Updated: December 18, 2008 00:03 EST