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8 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff analyzes the bad, the good, and the ugly of the now-signed Democratic-Biden $1.9 trillion stimulus package, focusing on some macroeconomic theory explaining why government stimulus doesn’t assist in recovery (which ironically is the “good” part).
I. THE BAD
CO Nation has a good grip on the bad. The $1.9 trillion spending package is part relief for people thrown out of work by the pandemic and government lockdowns, but the “stimulus” is largely pork programs, political pet projects, and bailouts for profligate state and local governments and public pension funds whose finances were strained even during the boom years before Covid.
Altogether direct check payments, extended unemployment benefits, expanded tax credits, and small business assistance amount to $848 billion or less than 45% of the $1.9 trillion being spent.
Also Cautious Rockers generally get that while many Americans could use relief, the economy itself doesn’t need fiscal stimulus. GDP and employment have already been recovering strongly in concert with the level of lockdown abatement.
Recently even the business press has been asking if stimulus is necessary given the strength of the most recent economic data: 10% annualized GDP growth in Q1, 379,000 jobs added in February and unemployment down to 6.2% from 14.2% in April.
Note also that no one was arguing a $1.9 trillion stimulus package was so urgent back in July of 2014 when the unemployment rate was also 6.2% under Obama—and declining at a snail’s pace compared to 2020/21.
CO readers are right to be skeptical that the rush to push through a giant stimulus package is little more than a hurried attempt to ensure this particular crisis—which is almost over—doesn’t go to waste, and that a supposedly struggling economy is being used as a pretext to push through as much gravy for politically-connected constituents as possible before the window of opportunity closes.
II. THE GOOD
This is the longest section but may be interesting to anyone who wishes to understand some of the theory behind what helps or hinders economic recovery from recessions.
On the question of “fiscal stimulus” the economics schools are divided roughly into two major camps.
Those for it: Keynesians, MMT’ers, and Socialists—roughly associated with Democrats and Socialists in the USA
Those against it: Austrians, Supply Siders, and most Monetarists—roughly associated with Republicans and Libertarians
The Keynesians argue that the economy needs more “aggregate demand" (spending power from consumers and business) to recover. And that government borrowing and spending money in ways that gets cash into lower and middle-income households’ pockets will produce more spending, thus stimulating the economy.
If we assume for the moment that under this theory there are no viruses frightening consumers and no lockdowns, the concept is that businesses are reeling, have factories and shops running at only a fraction of capacity (ie. idle capacity), and that once businessmen see consumers spending more they'll respond by hiring more workers and raising operational and capital investment budgets. From there the economy will run strongly on its own.
The Austrians and supply-siders argue that stimulating spending just prolongs what was an original error that caused the recession to begin with. An analogy is helpful here but for two sentences let’s put it in nerdy econ language:
“The unsustainable investment errors made by businessmen during the boom must be liquidated, and physical resources and other factors of production that were misallocated must be redirected to rational business lines that consumers will support under normal economic conditions, not temporarily ‘stimulated’ back to boom levels only to slump right back into idleness once stimulus is removed."
"The market process of reallocation results in some temporary job displacement, but the sooner it’s completed the sooner the economy can resume rational growth based on the consumption and saving decisions of the public instead of distortive central bank policy.”
To explain this in plain English we'll use a good analogy the Correspondent credits to Austrian economic historian Thomas E. Woods using a restaurant.
Take a restaurant owner in a small town doing a steady business.
Then one day the circus comes to town. The circus is an unsustainable boom or even bubble, usually produced by the central bank’s cheap money policy.
We’ll assume the owner is not an Austrian or supply-side economist, so he’s thrilled to see his store overflowing with new customers: clowns, trapeze artists, and acrobats. Not having enough tables, food, supplies and employees to handle them all, he borrows from a bank and builds a new, larger restaurant right next door and operates both at once.
This is the pre-recessionary boom.
But then suddenly, as is always the case, the circus suddenly leaves town when the bubble bursts, demand returns to its pre-bubble levels, and now the owner is stuck with a brand new, shiny, expensive second restaurant sitting empty and losing money—what Keynesians call “idle capacity.”
The Keynesian/Democratic line of thinking is for the federal government to borrow and spend trillions of dollars on stimulus—which strangely always takes the form of political payoffs and pork handouts to their friends and constituents—in hopes of getting something like the circus to come back. Then the owner can keep paying workers, ordering food, utilities, and equipment for his second restaurant.
But the Austrians/supply-siders ask “Is putting the second restaurant on life support really good for recovery?"
We already know the 'second circus' can’t last, and the moment the stimulus runs out the second restaurant, which was never sustainable to begin with, will go empty again only we’ll have trillions of dollars of debt to repay as well.
The Austrians argue building the second restaurant was a mistake to begin with and, as much as we hate to see it idle, there’s no way we can go back to the conditions that prompted its erroneous construction. It was built based on an illusion created by the central bank.
So as painful as it is, resources have to be allocated away from the erroneous investments and back to sustainable ones that consumers will truly support. In other words, liquidation. And the sooner it’s over and done with the sooner the economy can get back to rational, sustainable growth.
Even the classical economists of the 19th century understood that bad businesses started in the mania of a speculative bubble were mistakes and that, painful as it might be, the market must redirect misallocated resources as logically as possible to get on with life.
It’s a tragedy that the central bank directed concrete, steel, and parking lot asphalt to an erroneous project, and some resources like restaurant supply, furniture, and dishware will have to be sold off at firehouse prices (ie. devalued capital). If we’re lucky some ingenious entrepreneur might think of a cheap way to transform the building into a more usable business venue.
But there’s no reason to keep spending money on extra employees, food, restaurant equipment, and utilities that consumers won’t patronize without the government continuously borrowing and spending trillions of dollars in perpetuity.
If we go reductio ad absurdum to drive the point home:
If a speculative bubble spurred a businessman to build the world’s largest shopping mall in Antarctica, would it make sense to spend trillions in deficit stimulus every year in the hope of generating enough customers to keep his mall going?
Of course not. Let’s just admit it was a mistake and stop pouring even more money and resources into it.
OK, now apply the restaurant story to too much commercial real estate in the late 1980’s, or too many useless dot-com companies in the late 1990’s, or too much homebuilding in the mid 2000’s—all spurred by Federal Reserve cheap money bubbles—and apply the same logic.
Borrowing and spending trillions of dollars to temporarily boost demand for too many strip malls, dot-coms, or houses is simply throwing good money after bad. The moment the stimulus stops, economic reality reasserts itself and the stores, dot-coms, and homebuilders start to lose money and retrench… which they should have been allowed to do from the beginning.
Incidentally this is why every time a round of stimulus money is spent we see headlines that GDP popped up for a quarter or two at most. Then when the stimulus money is gone the headlines report that GDP growth sharply declines and the economy returns to malaise, sometimes with talk of a double dip. We’ve all seen it before.
It’s also why the Obama administration racked up almost $10 trillion in debt during its two terms yet produced the slowest GDP recovery in American history and the second slowest recovery (behind only the Great Depression) from a financial crisis to full employment.
So taking medicine tastes bad and liquidating mistakes that can’t be sustained isn’t fun, but it’s necessary. Just as a hangover after a drinking binge is no fun, but it’s a necessary part of the body regaining its health. Austrians argue that following the Keynesian prescription—chasing the hair of the dog (drinking more alcohol to cure a hangover)—might feel better in the short term, but it only delays the necessary solution and at far greater cost.
III. SO WHAT’S GOOD ABOUT THIS STIMULUS?
What we’ve described with our restaurant example is a classic recession—irrational misallocations of resources incited by central bank easy money such as the slumps of the early 1970’s, early 1980’s, the late 1980’s post-S&L Crisis recession, the 2000-02 dot-com recession, and the 2007-09 Great Recession.
But 2020 is different.
In early 2020 there were very few massive misallocations of resources spurred by the central bank that failed en masse just waiting to be logically reallocated. The economy was functioning rather well, but it was artificially placed in a coma by a virus and lockdowns.
So what the economy needs today is to be freed—vaccines, herd immunity, and whatever else it takes to lift government restrictions and give consumers the medical confidence to resume their pre-Covid economic behavior.
And although the economy certainly doesn’t need stimulus, perhaps now you can see why government deficit spending won’t be as harmful this time around: there are no major resource misallocations for the government to perpetuate with its spending. Barring a new virus, the Fed jacking up rates to 10%, or an unexpected event like war, the economy will rebound very nicely all on its own once the virus is controlled and lockdowns ease.
So the good is the stimulus won’t have the opportunity to do as much damage to the recovery as it has in conventional recessions. At most it might produce an uptick in inflation, but not another 2008-15 malaise or three Japanese “lost decades.”
(BTW the correspondent is not ruling out *other* anti-growth initiatives that might come later from Congress and the White House, but history shows it's going to take a lot of really bad ones to stop this recovery)
IV. AND FINALLY, THE UGLY
The ugly part, other than the wasted money and pork handouts, is mostly rhetorical.
Time and again governments have tried stimulus measures to end conventional recessions only to prolong the slumps instead.
Japan has tried stimulus more than anyone in world history and has three lost decades of sub 1% economic growth to show for it, and a giant debt to boot—the equivalent of a $55 trillion national debt in the United States.
Herbert Hoover and FDR tried the greatest Keynesian stimulus in the history of the United States and it took 17 years to get to full employment (if you include World War II when 12 million men were drafted and artificially removed from the workforce) along with the worst economic contraction in American history.
And we already mentioned the failure of Obama’s stimulus spending and deficits.
Yet Keynesians, who every time promised rapid recovery, backtrack in the wake of each failure with another “the stimulus just wasn’t big enough” or “we underestimated how bad the economy was” or “well, it would have been even worse without the stimulus.”
Never mind every recession before 1929, where fiscal stimulus was not only not tried, but didn't even exist as a policy yet, recovered years faster than 1929, 2008, or Japan’s three lost decades. The Depression of 1920-21, which was the second sharpest contraction of the 20th century, was over in 18 months and full employment attained in two years (precisely why it's not in the history books) while President Warren Harding’s administration did nothing other than cut the government budget.
But in 2021 we have an economy that is going to recover strongly on its own, and in fact already has when compared to the depths of last spring’s blanket lockdowns.
Yet President Biden and the Democrats are about to borrow and spend $1.9 trillion anyway, and afterwards Keynesians will claim it was the stimulus that produced the recovery. “See, when you’re willing to employ a large enough stimulus the economy recovers quickly” they will say. “This proves Keynesian stimulus works.”
Hopefully Americans will be smart enough and have long enough memories to recall that, six months before the stimulus was even signed when lockdown measures were already being loosened, unemployment had already fallen eight points (14.2% to 6.2%) and GDP was growing at an annualized rate of 10% in early 2021 and even 33% in the third quarter of 2020.
But the Economics Correspondent suspects that won’t stop Keynesians from trying anyway. If they haven't given up after expensive failures in the 1930’s, Japan, and 2008, what makes anyone think they’ll stop this time?