Why stimulus spending is a bad idea

Sadly, stimulus spending as an economic cure may make things even worse than they are.   It probably will not provide the results its promoters want although it will likely lead to a more egalitarian but poorer economy because there is a possibility it would lead to some heavy-duty inflation.

The ideal way to deal with the economic crisis requires  a major change in economic thinking and values starting with the way in which money is created.  Some ideas are in my essay “LETS go to market: dealing with the economic crisis.”  Of course this is not a realistic proposal. Its implementation would require a dictator with a strong and loyal military and this is contrary to my belief that decision-making should be made by individuals.

chovynz_Money_Bag_IconThat leaves austerity or stimulus.

The basic problem is that we have used up a big chunk of the easily accessible resource base.  There may be lots of energy and minerals left in  the surface  of the planet but they are so difficult and expensive to extract we cannot expect continued economic growth.

If this is a correct analysis then austerity will be forced upon us regardless of what we do.  The real challenge is to cope with austerity with a minimum of human suffering.   The problem with austerity as it is being promoted is the selfishness and meanness of those promoting it on the backs of people who are less fortunate.

But what about stimulus?  At least since Keynes, many economists have and continue to believe the way to get economic growth going is via government stimulus.

There is some evidence the depression of the 1930s was made worse because the banking authorities restricted the amount of money in the economy.   Once governments started spending (works and war) and the money supply was allowed to increase the depression came to an end.  This time  central  banks have been trying to stimulate the economy by creating more money to facilitate more economic activity.  It isn’t working  because the resource base won’t support more economic growth  although only a few people see that as the reason.

So what is likely to happen if the Keynesians get a turn at trying to solve the crisis.

There are two difficulties.

The first is that stimulus will be a transfer of purchasing power from those who now have it to others because the debts incurred will eventually be written off either by default or by inflation.  Cyprus isn’t the only country whose savers are likely to be hit.

The puzzle is why with all the quantitative easing and no matching growth in output we haven’t had inflation.  The answer:  there is anecdotal evidence that the banks and corporations are sitting on piles of cash presumably because they don’t  see profit opportunities.

Governments don’t worry about profits so if the money goes instead to governments for stimulus, it will be spent.  There will be more money chasing the same quantities of goods and services and prices are bound to go up.    Inflation provides an indiscriminate haircut to everyone with monetary savings or investments.  If it gets out of control a lot of people will lose their pensions or their fortunes.  It will solve the inequality about which many people have been worrying.  It would also be a neat revenge against those people who want austerity on the backs of poor people although a lot of innocent people would be hurt.

The second problem with stimulus is that if it succeeds in increasing the output of goods and services it will also use up more of the remaining mineral and energy resources and bring forward the timing of a major crash of civilization.  I would like the goal of economic policy to be to minimize overall  human suffering rather than to increase it.

I am not worried about an economic collapse for my own sake, but I do have six young grandchildren.   Perhaps we should post a job opening for a benevolent dictator.

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2 Responses

  1. Interesting points. Can you provide any empirical evidence in favor of austerity? Let’s take for example the current situation in the US (after a fiscal stimulus) and EU (after austerity measures), in terms of employment and economic growth.

  2. A little knowledge is a bad thing. Yes, properly designed stimulus spending will get the USA out of a DEPRESSION.

    1. The USA is in a Depression, not a Recession which is technically different. The main difference is that in a Depression reducing interest rates will not work. The economy is in something called a ‘liquidity trap’. Increasing the money supply will only eventually cause inflation. Otherwise it ends up and stays in the Banks, not lent. Keynes called these policies ‘pushing on a string’.

    2. You could as you say do nothing. Recovery will take a very long time. And very, I mean very. Japan has been in a liquidity trap for over 12 years with no sign of recovery. For recovery, bad debts, inefficient practices and inefficient workers have to be removed from the system. Governement expenditure must be massively reduced – that causes ‘crowding out’. Recovery will take a long, long, time. Maybe never, and things get worse as the government loses credit.

    3. Speed up recovery? It is possible but difficult. People talk glible of ‘fiscal policy’. Only certain expenditures are expansionary. Those that have a ‘multiplier’. Basically expenditure on engineering works and infrastructure. On steel and concrete. Fiscal expenditure on welfare and public servants have a negative multiplier.

    I understand people getting disenchanted. The present US government administration reminds me that of Herbert Hoover. Well meaning but ineffective.

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