Today, The Economist is facilitating a discussion between the two sides of the stimulus debate. On one side of the spectrum is Richard C. Koo, Chief economist at Nomura Research Institute, who opens his argument with:
Monetary policy is largely useless in this type of recession because those with balance sheets underwater are not interested in increasing borrowings at any interest rate.
The Obama stimulus is an example of bad advice leading to bad policy. Much of the pressure for additional stimulus now comes from those who want to repeat their error.
Does America need another fiscal stimulus? In a few weeks’ time Barack Obama will urge Congress to give the economy an added boost, such as by extending a payroll tax cut and enhanced unemployment insurance benefits. Republicans in Congress sound skeptical. The GDP revisions show that the economy had fallen even further during the recession than the Obama administration realised at the time of its first plan. The paucity of results naturally raises a question: does such stimulus work? And should we have more of it?
Like Japan (once did), America has experienced the collapse of an asset bubble. Because its private sector is trying to chisel away at debts accumulated during the inflation of that bubble, it is reluctant to take on additional debt no matter how low interest rates are.The only way for the government to keep the economy from collapsing is to borrow and spend the unborrowed savings in the private sector and put them back into the economy’s income stream.
The economy has shown so little response to the massive injections of stimulus because it was badly designed and flouted some elementary principles of human behaviour. First, the bureaucratic delays inevitable when executing even “shovel-ready” projects mean that much of the money took too long to be spent, or has not been spent at all. Finally, sceptics add one more indictment of the stimulus: by expanding the welfare state, it added to a pervasive and suffocating atmosphere of uncertainty that has discouraged business from hiring and investing, and individuals from making big purchases.
I am an economic historian, and both economics and historical experience demonstrate that federal incursions into economic activity are counterproductive; some textbooks talk about the Policy Ineffectiveness Theorem. Aggressive deficit spending and Federal Reserve monetary expansion led to stagflation in the 1970s. Japan went on a huge binge of stimulus spending in the 1990s and economic growth virtually ground to a halt. The excesses of the European welfare state and its funding are causing crises all over the European Union, from Ireland to Greece. The Obama Administration engaged in stimulus plans accompanied by rising, not falling unemployment. Bailouts and “too big to fail” policies have created a huge moral hazard problem. The Federal Reserve has engaged in huge purchases of government long-term bonds and mortgages to keep long term interest rates low, but long term interest rates are not falling as concerns about potential inflation justifiably have risen. By many indicators, this is the weakest postwar recovery. The Fed and the government have monetary and fiscal time bombs threatening both short-term recovery and long term financial and economic vitality.
All of this amounts to a rotten-apple operation. The contents of the economic barrel are still a mess. If the government and the Fed continue to pour trillions of dollars into efforts that do nothing more than polish the rotten apples, the entire contents of the barrel will become less and less valuable over time. Keynesianism was a bogus theory from the start. Thinking about why the economy succeeds or fails in terms of a handful of economic aggregates conceals everything we need to know if we are truly to understand it. Supposed experts who can’t tell a good apple from a rotten one should be kept out of the orchard. They are not helping. Indeed, they have made matters much worse at this point than would have been the case if the government had done nothing at all to reverse the recession.