Deflationary stimulus and stimulating taxes?

A friend recently send along a link to the latest quarterly review from Hoisington Investment Management.

The point it makes that of the conditions required for inflation, essentially that there is a desire to invest and increase economic capacity, we currently meet none. Meanwhile, empirical evidence cited (and yes, we're always a little suspicious of that) suggests that US government spending does not have a Keynesian multiplier significantly different from zero. In other words, most government spending does not increase economic activity so much as shift it from private to public expenditures.

How does this work? Consider the demographics of graduate school enrollment. It grew even during the boom year, as students with technical degrees were largely faced with the choice between grad school and investment banking (there were exceptions, like chemical engineers). Now, IB isn't much of an option, although government planning might bring it back. Goldman's sure doing well.

However, for most of those students, grad school has largely become industry R&D on the cheap. The government has piled into the game, and now quite a lot of projects that used to go on in places like National Labs, Bell Labs, Xerox Parc and at drug companies now goes to people making 30-60% for the first few years of their careers. Government sponsored research into the energy industry has, according to the President, reduced solar cell prices by something like 80% in twenty years. This shifts the aggregate supply curve to the right, making economic activity cheaper.

In normal times, that's a good thing. Productivity goes up, inflation stays under control. In times like these, government research spending is actually deflationary. Ask Japan. On the other hand, if the Henry-Waxman climate bill actually does anything to increase the costs of emitting carbon, it will spur private sector investment, since it will be cheaper for large companies to plow money into the private economy than the government.

Shifting the AS curve left is an inflationary move. We're entering a deflationary cycle. We've got simultaneous climate, energy and debt problems to solve, and we the taxpayers own a car company that we really want to make money selling small cars.