Against the stimulus

on Mar 23 in Financial Market, Politics tagged by Trevor Hicks

I thought I might explain a little more in detail why I’ve opposed the massive stimulus.  The Keynesian story about macroeconomics says that when the business cycle turns down, aggregate demand in the economy (from both businesses and individuals) drops, thus reducing output which leads to more drops in demand.  Government can stop this vicious circle by temporary borrowing and spending to boost demand.  This is perfectly valid thinking and is the theoretical basis for such stimulus packages.

Our current situation does include a substantial drop in aggregate demand, but what has caused it?  In the interest of brevity I’ll skip over many of the mechanisms and blame-assignment, simply put over the last decade we (as an aggregated nation) seriously overestimated the value of our houses.  Unfortunately, we then proceeded to borrow to the hilt against those inflated valuations.  Now that valuations have dropped, we are left with a lot of debt that is and will be difficult to service putting both borrowers and lenders in trouble.  And as the value of our portfolios have dropped, we have started saving, causing a drop in aggregate demand and economic output.

In this situation, a fiscal stimulus is analogous to a nasal decongestant when you have a cold.  It can make you feel better by treating the symptoms, but it doesn’t really fix the problem.  And so “feel better” measures like extending unemployment benefits and helping out with COBRA payments are probably good ideas to ease the pain of the economic changes.  But blowing trillions of dollars on pork barrel projects is really making the problem worse by piling on more and more debt to get assets of dubious value.