Did the Iraq War Lead to the Current Lack of Aggregate Demand?

Jerry Estill reports that President Bush, Senator McCain, and Senator Clinton are partly responsible for our current economic woes because they failed to actively oppose the invasion of Iraq:

“It’s a Washington where politicians like John McCain and Hillary Clinton voted for a war in Iraq that should’ve never been authorized and never been waged – a war that is costing us thousands of precious lives and billions of dollars a week” that could be used on infrastructure, job training and health care.

I agree that there was a huge opportunity cost in diverting as many resources as we did to our occupation of Iraq and these resources could have been directed towards infrastructure, job training and health care. But to say an increase in government spending leads to a fall in aggregate demand strikes me as quite odd.

The usual line of reasoning for this theme seems to be some sort of indirect impact on residential investment, which of course has plummeted. But those who emphasize the residential investment angle have a couple of different – and perhaps contradictory – channels. Some would argue that the Federal Reserve kept interest rates too low, which lead to over-investment ala the Austrian school of economics. But trying to tie this to what Senator Obama said has the following problem – fiscal stimulus tends to increase interest rates.

Then again – the housing bubble burst followed a period where the Federal Reserve did increase interest rates. When the Federal Reserve was increasing interest rates, however, the thought was it needed to do so to avoid demand pull inflation. The continued fiscal folly of the Bush Administration was sort of like the 1981 fiscal folly under President Reagan. And the Federal Reserve slammed on the monetary brakes back then very hard, which led to the 1982 recession. Maybe we are watching a repeat of this horrific mix between fiscal stimulus and tight money. If we are, there are lots of things adding to the fiscal folly besides the stupid war, such as those tax cuts that John McCain now loves and that prescription drug benefit that Bush keeps bragging out.

With all of this said – Obama’s rhetoric here strikes me as a real stretch! After all, ending the war today and lowering defense spending (which I’d support) would reduce aggregate demand.