The Fiscal Stimulus Follies

A large chorus now sings the praises of some fiscal stimulation for our economy. Both parties support fiscal stimulation, though each party has a different slate of favored candidates. Fiscal stimulus can result from either government taxing less or spending more. Democrats are generally more inclined to support government spending, Republicans more inclined to support tax reduction. In either case, the central claim in support of fiscal stimulation is a simple one. That claim, however, is as wrong as it is simple.

The simplicity resides in the idea that more spending causes more prosperity; indeed, that it is spending that causes prosperity rather than prosperity that causes spending. There are, moreover, two sources of spending in our economy: people and government. People spend both as individual consumers and as business investors. Total spending in an economy is the sum of what people spend as consumers and business investors, plus what governments spend.

If people individually reduce their spending, the fiscal stimulists claim that government can fill the void by spending more. This is a portrait of government spending as providing a “shot of adrenaline for a slumping economy,” to cite a common image. To shift metaphors, the fiscal stimulists portray an economy as if it was a balloon. The problem of economic policy is thus one of controlling the air pressure in the balloon that is the economy. The task for policy is to keep a nicely filled balloon. This requires the avoidance of two extremes. One extreme is to inflate the balloon too much, so that it bursts. The other extreme is to let the balloon become so flat that it looses its buoyancy. In either case, the economy is portrayed in starkly simple terms, as the images of air pressure or adrenaline suggest. We are led to believe that it is easy to administer the correct policy, and to do so at the right time.

There are a number of problems with this common portrait. The central problem is that this portrait of economic life and processes conforms neither to reason nor to experience. An economy does not have the simplicity of a balloon. To the contrary, it is a complex web of commercial relationships that defies anyone’s ability to organize or control. It is out of recognition of this immense complexity that economists have hit upon such allusions as that of an “invisible hand” to express the character of economic activity. This allusion recognizes both that economic activity is highly organized and that this organization is not anyone’s creation or responsibility.

Metaphorically, an economy is much more like a gigantic erector set that runs throughout a large hotel, with each node connected to nodes in many different rooms, and with no person or office able to master the operation of the entire set. Changes initiated at one point will exert impacts throughout the system, and will do so with varying time delays. Today’s economic occurrences and disturbances are a complex, only partially apprehensible result of previous changes in many places at many different times in the past.

A number of smaller problems follow from this central problem. One is the time lapses that are involved. People may reduce their spending in January, but this won’t even appear in the statistics until March or April. To allow the legislative process to work today, at the earliest it will be late-summer or early-fall before any stimulatory measures can take effect. By the time those measures start to take effect, people might already have resumed their earlier spending patterns. If so, the fiscal stimulus can create hyper-stimulation.

The fiscal stimulists assume that any reduction in private spending is bad and is to be resisted by increased government spending. In many cases, however, reductions in private spending are caused by earlier government programs. For instance, a stimulatory program two years ago might have induced people to make investments that they must now liquidate. The reduction in investment spending today was caused by the fiscal stimulus provided two years ago. What we have is fiscal stimulus in the past causing people to reduce their spending today. Today’s reduction in spending, moreover, is then used to justify still more fiscal stimulus. Just as a morning snort might help one get past a hangover, so it is with fiscal stimulus.

There is, however, a better remedy. What we need is not yet more fiscal stimulation. We already have had far too much for far too long. What we need is small government that does a few things well and in a stable manner. We do not need a large government that continually tries to manipulate economic conditions. It can’t do this successfully and only creates problems by trying – problems, unfortunately, that are used to justify even more doomed governmental efforts at economic control.