It has been claimed—Congresswoman Nancy Pelosi (D, CA) is the most famous proponent of the theory—that unemployment payments to the unemployed are inherently stimulative: the recipients promptly spend the money. The stimulus is assumed to come from what’s called the velocity of money.
The velocity of money is a concept in economics that looks at how many times a dollar gets turned over in a local economy: a man buys groceries and pays rent, the grocer pays his clerk, who buys…, and the landlord hires maintenance workers, who then spend on…. The velocity aspect comes from measures of how many times that dollar gets turned over before it disappears from—has been consumed by—the local economy.
There are holes in the premise that unemployment payments are stimulative; here are some.
Unemployment payments are from tax money taken out of the private sector—which means it’s money not turning over in the private sector until it’s returned as those unemployment payments. Moreover, those unemployment payments are less than what was originally collected for the purpose—the difference is lost to the friction of government. The amount of money that can be turned over is lessened.
Further, the unemployed don’t buy the more expensive things with their unemployment payments; they buy the low cost items in the grocery store. These are low-margin items for the grocer, though, and so they lower, a little, the overall margins of the store. The grocer thus has a little less money with which to do his own purchasing (and perhaps hiring). Turnover is slowed.
On the other hand, money (left) in the private sector gets spent on a variety of things (60%-70% of our economy is consumer spending), including on more expensive items in that grocery store—which helps expand, a little, that store’s overall margin. Turnover is greater.
Money left in the private sector, rather than returned to it as unemployment payments, also gets saved, to an extent (a large part of the remaining 40%-30% after consumer spending), or used to pay down existing debt (another significant fraction of those 40%-30%). Saved, or returned to a financial institution as debt payment, these funds improve the credit-supporting aspect of our economy: they’re funds financial institutions can lend out to support credit card-supported purchases or to support the purchase of big ticket items like cars and houses. More money is available to be turned over.
Savings and debt repayments also are funds financial institutions can lend to businesses for capital improvement and/or expansion and to startups to support their gutsing up or subsequent growth. Here are jobs in the making, and an expansion of the money in the private sector—in the hands of individuals. Here, also, is a reduction in unemployment and so of the need for unemployment payments. More money is available to be turned over.
This is not to say that unemployment payments must never be made under any circumstances. However, a more accurate understanding their real effect on our economy will enable us to make more efficient use of such payments.