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The Folly of Stimulus

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Tags Booms and BustsBusiness Cycles

02/01/2008Christopher Westley

The Free Market 26, no. 2 (February 2008)


Years of spending, inflating, taxing, and redistributing has left the US economy teetering on a recession that our best and brightest—meaning the ones who created this mess—claim requires a multibillion-dollar economic-relief package to quell fears, promote confidence, and spur recovery.

And, one might add, to keep things calm past election time, which is the real purpose of this bipartisan effort to “stimulate” the economy out of recession fears.

It leaves you wondering about what happened to the 1990s boom, a credit-fueled expansion also influenced by a peace dividend. The end of the Cold War produced a floundering federal government that lost its rationalization to grow and found itself unsure of its purpose, thus promoting an era of relative peace and prosperity.

Oh, how things changed in the 2000s, with new monsters to destroy and new justifications for centralized power! Table 1 lists just a few of the results of these policies, and it explains why the presidential candidates are all about the change-change-change! Unless you are long on gold or short on bank stocks, who benefits from the status quo?

The difference between the 1990s and the 2000s expansions is that while the former relied less on the fiscal tool of debt, fiscal and monetary tools defined the latter —economic interventionism’s double whammy of debt expansion and money creation. Both tools are preferred by politicians who receive short-term benefits from growing the government while not forcing the current generation to pay for it.

Both also are preferred forms of taxation because they shield the full cost of government from current voters. Debt shifts tax obligations to future generations, while inflating the money supply is a pernicious consumption tax because it makes you pay for big government in the form of higher prices.

The end result, however, is an unsustainable boom followed by an inevitable bust, the beginning of which we are starting to see right now. Yet, the solutions being aired by establishment thinkers on the Left and the Right call for more of the same. Boys and girls, the word for 2008 is “stimulus”—a new round of debt and inflation to forestall the inevitable correction.

All plans are still murky, but the total size of the economic stimulus package should fall between $125 to $2,000 billion in tax cuts, targeted spending, and rebates. Check your mailbox. You may find a government check between $600 and $1,600 sometime before the April 15 tax deadline. One certainty is that we’ll know the details soon.

Let’s recall the economic justification for such policies. They are based on myths that have persisted since the Depression that sticky prices cause markets not to clear, resulting in an oversupply of goods and a disincentive by firms to expand production and hire labor. This inability by the price system to adjust downward when market conditions change reflects a failure inherent in the market system, thus requiring extra-market intervention by central planners, whose solution involves policies meant to increase consumption. If that happens, the resulting increased demand for goods and services allows markets to clear, notwithstanding price rigidities.

Or so goes the justification. The many problems with this scenario include the fact that prices actually do adjust downward—rigidities are rare in competitive markets and more common in regulated ones. So if markets are not clearing in the midst of a correction, the problem is outside the market. The culprit is interventionism, not the price system.

Say you run an automobile factory and no one is buying your cars at the average price of $20,000 each. Your dealers’ lots are growing and your supply chains are getting clogged—both indicators of a downward pressure on prices. You can either (a) cut back production and lower your average price, or (b) wait for consumer demand to increase. The planners now formulating stimulus packages assume that you and millions of other economic actors facing similar choices will opt for the second strategy. Since markets would fail us when this happens, they require some manipulation of consumer demand for them to work.

An objection to such policies— besides the obvious ones dealing with their similarity to those of Italy, circa 1933—is that they set the stage for a more significant correction in the future. Policies that force consumers to spend are also policies that force them not to save, and saving is essential for longterm, sustainable economic growth. When people don’t save today, they consume less in the future, again causing inventories to rise and supply chains to become clogged. At best, forced spending can only postpone market corrections, and the more it depletes saving, the more severe the eventual correction.

It doesn’t help that such demand-side policies themselves became sticky, entrenched as Keynesian policy institutions. While much of economics as a science has moved on from Keynesian theory— meaning that it has moved closer to the Austrian position, which was contra Keynes from the beginning—old policy levers maintain political value. They often show up in the form of calls for economic stimuli.

The problem for free-market economists is that their policy recommendations at the dawn of recession are not too sexy to the political mindset. They involve either doing nothing to hinder price adjustments, or actively removing extra-market barriers to price adjustments that already exist. This often involves short-term pain in exchange for long-term solutions, when politics rewards short-term solutions that result in long-term pain.

History proves this point. Prior to the creation of such barriers, economic corrections were much shorter affairs. Recessions were called panics and they rarely lasted more than three months. Massive, sustainable wealth was created —indeed, the Industrial Revolution occurred under these conditions. It was only when those who would obstruct necessary price and wage adjustments during a correction became a permanent part of government bureaucracy that real growth rates tapered and business cycles began to measure longer and more painful corrections, each requiring a new round of so-called stimulus.

That is what we are experiencing today. It is the folly of governments to spend, inflate, tax, and redistribute.

Cite This Article

Westley, Christopher. "The Folly of Stimulus." The Free Market 26, no. 2 (February 2008): 1–3.

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