The foolishness of economic 'stimulus'
Do we really want to risk prolonging a bad economy?
By Donald J. Boudreauxfrom the January 24, 2008 edition
Page 1 of 2
Fairfax, Va. - A consensus is building that America's economy is sliding – perhaps plummeting – into recession. In December the unemployment rate jumped to 5.0 percent, up 3/10ths of 1 percent from its November level. And of course investors are now growlingly bearish.
To no one's surprise, politicians are rushing in with various plans for helping the economy. Most of these plans involve "stimulus." The calls are loud to put more money into the hands of ordinary Americans in hopes that they will spend – not save – it, thereby boosting the overall economy.
Such stimulus, however, is futile. Government cannot create genuine spending power; the most it can do is to transfer it from Smith to Jones. If the Treasury sends a stimulus check to Jones, the money comes from taxes, from borrowing, or is newly created.
If it comes from taxes, the value of Jones's stimulus check is offset by the greater taxes paid by Smith, who will then have fewer dollars to spend or invest. If Uncle Sam borrows to pay for the stimulus checks, this borrowing takes money out of the private sector. Any dollars borrowed – whether from foreigners or fellow Americans – for purposes of stimulus would have been spent or invested in other ways were they not loaned to the government.
The only other means of paying for such stimulus is for the Federal Reserve to create new money. Unfortunately, this option leads inevitably to inflation.
All Americans wind up with more dollars in their wallets but also paying higher prices in the stores. Prosperity is not created by raining down upon the populace more monochrome pictures of dead statesmen.
Stimulus funded with newly created money is especially harmful. Most obviously, the inflation it causes prompts investors to flee the dollar. But because inflation can take time to show up, injecting new money into the economy can create a temporary sense that consumers and investors are wealthier than they really are. Such a false sense dangerously delays the necessary pruning of unfruitful investments. A bad economy is prolonged.
"It's only when the tide goes out that you learn who's been swimming naked." That saying, credited to Warren Buffett, points to the important – if painful – role that recessions play: moving money from bad investments to sound ones. Delaying this adjustment with the hallucinogen of easy money does no one any favors over the long-run.
Spending power is not so much the fuel for economic growth as it is its reward. And the key to economic growth is investment that raises worker productivity.
The best way for policymakers to foster such growth is to avoid panicking over any current economic downswing. Instead, they should focus on getting the economic fundamentals right. Such emphasis might not make things better – or even make things appear to be better – today, but it will make our tomorrows as bright as possible.
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