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Why More Federal Spending Isn’t the Answer for Fixing the Economy

Friday January 6th, 2012   •   Posted by Craig Eyermann at 8:03am PST   •  

Since the most recent recession began in December 2007, the United States’ government and Federal Reserve have spent unprecedented amounts of money trying to put the U.S. economy back together again. As with the story of all the king’s horses and all the king’s men efforts at repairing Humpty Dumpty, both would appear to have run out of effective options:

“The economy has become almost numb to fiscal and monetary stimulus.” That’s according to Anthony Sanders, senior scholar with the Mercatus Center at George Mason University. Sanders looked at four main factors and determined that there’s little the federal government can do to actually stimulate the economy at this point.

First, additional federal debt has little impact on GDP growth, so additional fiscal stimulus is unlikely to achieve economic growth.

Second, the M1 Money Multiplier has been dropping for decades and crashed during the recent recession.

Third, M2 Velocity (a measure of the effectiveness of monetary policy) has crashed as well. In other words, monetary policy is relatively ineffective.

Finally, interest rates have been driven to zero at the short end and have very little room on the mid-to-long end,” Sanders said.

The reason for the economy’s resistance to stimulus, according to Sanders, was also predictable.

“This is the aftermath of a credit bubble. Basically, the government relaxes credit (or fails to supervise) and a bubble forms and bursts. As could have been predicted, Fannie Mae and Freddie Mac, the formerly private government-sponsored enterprises, have been effectively nationalized,” Sanders said.

“Credit has contracted rather severely. This is one reason why the housing market, and the national economy as a whole, have taken so long to recover.”

Just as a hammer isn’t the right tool for drilling holes, excessive federal spending isn’t the right tool to fix an ailing economy.

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January 2012