Saturday, January 24, 2009

Why Fiscal Stimulus?

Obama's fiscal stimulus plan is the culmination of a return, by desperate politicians, to an idea that recently had been out of fashion. For the last twenty five years or so, manipulating the economy was strictly the dominion of central bankers using monetary policy. We would be treated to wonderful commentary on whether the economy was "overheated" and in need of higher interest rates to cool it off or "cooling" and in need of lower interest rates to heat it up. A balanced budget was the ideal; the Democrats never really achieved one, but they came close at the end of Bill Clinton's term. We then actually went through a period of projecting budget surpluses for the foreseeable future. So much for the idea of foreseeability.

Perhaps the renewed belief in the efficacy of fiscal policy to stimulate the economy is related to the new lack of confidence in the Fed's ability to fine tune the economy with monetary policy. Former Fed chief Alan Greenspan, once the "Maestro", is now discredited; the econometric modeling that failed him so profoundly has not yet, unfortunately, met the same fate. Ben Bernanke has not restored confidence in Fed competence. Also, interest rates are already at rock-bottom levels; they cannot get much more stimulating. Counter-cyclical fiscal policy, i.e. budgetary deficits to heat up the economy during economic slowdowns and budgetary surpluses to cool down the economy during a period of overheating actually fell out of favor for some very good reasons that have relevance to our current malaise.

Fiscal policy comes from the Congress, which makes it notoriously slow to be enacted. Add that to the fact that the economic statistics used to determine whether the economy to needs a heavier foot on the gas or a foot on the brakes lag behind actual events and it is easy to see why fiscal policy had fallen out of favor. Official statistics have finally told us we are a year into a recession. We are now being told that we will not see any stimulus bill pass Congress until February. The main rationale for the bill is our need for "investment" in infrastructure. Those big projects may not take off for almost a year. Lack of timeliness is a big problem with using fiscal policy to counter economic cycles.

Fiscal policy has other problems that will not here be detailed. Foremost, in my mind, is that even if fiscal stimulus could be brought to bear in a timely fashion, it would still fail. Remember when we rushed to get a $165 billion stimulus bill under Bush? Then recently we just had to authorize $800 billion willy-nilly or the sky would fall. The sky is falling anyways. We would be wise to have our doubts about the next round of stimulus.

The simple fact is that government is incapable creating real wealth. Huge government deficits only guarantee one thing--wealth destruction through distortion of the capital structure. Idle assets will not be put to productive use. True wealth production will, on the margins, be sidetracked in pursuit of short-term, unsustainable gains from government largess. So what is the proper policy, both fiscal and monetary? Spending by Congress should be cut to a minimum and the Fed should do nothing. We need a revival of good old fashioned unfettered capitalism.

1 comment:

  1. Thanks to Downsizedc.org!

    Quotes of the Day: “Is it too much to ask that someone criticizing (John Maynard) Keynes actually, you know, read Keynes…?” -- Paul Krugman
    Okay Mr. Krugman, let's read what Keynes wrote in 1942 . . .
    “Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.” -- Keynes, Collected Works, vol. XXVII, p.122

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