Deciding if the fiscal stimulus is productive, a wash or a drag on economic activity has inspired a furious debate in economic circles this year. Some of the analysis is wickedly complex. In the interest of brevity (and clarity), Professor Eugene Fama has boiled down the key issues as follows:
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
The debate necessarily focuses on #3. That is, will the government’s stimulus spending end up in more productive investments relative to what the private sector would do with the money? History suggests we should be skeptical in answering “yes” in anything close to absolute terms. Of course, some government spending is productive, particularly when it goes into projects that are unlikely to find financing otherwise. The development of highways, for instance, to cite the standard example.
Daily Archives: December 30, 2009
REFLECTING ON 2009
We’ve had the Great Recession and the Great Liquidity. Next comes the Great Unknown.
Central banks have averted the Great Depression 2.0 courtesy of liquidity injections on an unprecedented scale over the past 18 months. In essence, the Federal Reserve and its counterparts around the world have eased the economic and financial pain relative to what would have occurred in the absence of government intervention. If you give the patient enough morphine, he feels better. But what happens when the nurse visits cease? Or will they cease?
The first phase of the Great Intervention has generally drawn cheers and high marks. Certainly the capital and commodity markets in 2009 have registered their approval by way of higher prices. The risk of deflation has been materially reduced. Meanwhile, economic growth has returned. News that that U.S. GDP expanded in the third quarter, for instance, is widely celebrated as proof that the monetary and fiscal stimulus have been a success.