Sunday, April 3, 2016

Why econonic stimulus never works

During an economic downturn, it's believed that a proper role of government to is stimulate the economy back into health. This has been a standard practice for almost a century in the United States and is practiced world wide. There's another school of thought which proposes that the government should instead do nothing and permit the recession to correct on its own. Many people have a difficult time understanding why or how it could be better for the government to do nothing (especially politicians). If a person is unhealthy and needs medical attention, doing nothing can be fatal. Action, even incorrect action, is given preference over inaction. Yet as I'll demonstrate shortly, in the case of economic growth, the "do anything" attitude not only fails to correct the original cause of the downturn, it actually results in worsening conditions.

Consider that you're traveling in a car, driving south to visit family. You pull off of the highway into an unfamiliar area to refuel. In the process of getting back onto the highway, you end up heading back north instead of going south. Is it better for you to discover this mistake sooner or later? The later you realize the mistake, the more time and fuel you will have wasted going in the wrong direction. You might not even make it to visit your family.

Consider that at some point in your journey, you start to realize your mistake. You begin to slow your vehicle down to either stop to review the map, or to turn around completely. Now imagine that someone in the back seat of your car starts yelling at you to speed up. They tell you that you are headed in the right direction, and if you slow down you won't make it in time.

Should the person in the back seat keep quiet and "do nothing", allowing the driver to correct the mistake, or, should the person try to pressure the driver to continue driving in the wrong direction?

This is the effect of economic stimulus. Downturns or recessions happen for reasons: because of bad choices made on a large scale. Stimulus doesn't correct those choices, it enables them. Policymakers are more than happy to oblige, since it grants them greater power over the economy. Economists are also more than happy to propose stimulus too, because it gets them positions as advisors to policymakers.

The proper action for the government in the event of a recession is not just to do nothing, but to permit the correction to take place as quickly as possible. Stimulus does not achieve that end.