All entries for April 2009

April 13, 2009

Economic Stimulus

Towards the end of last year the government chose to attempt to stimulate the economy using fiscal means – that is to say that spend more (creating jobs) and tax less (incentivizing purchases and harder work). This is a traditional remedy in time of economic strife – action that the government can undertake to encourage the economic to grow faster, or shrink less in this case.

The conservatives opposed the measures on the grounds that they would increase government debt. Debt they argue is bad because it its hard to repay, it requires that at some point in time in the future one must either raise taxes or cut spending – either way the economy will be damage by the inverse effects of the stimulus. Some commentators pointed out that the stimulus would only increase the fiscal deficit (ie the amount added to national debt) by 1/15 of the amount that it was going to rise by anyway, and the Conservatives weren’t opposing the ‘stabilizers’, ie the natural reduction in taxation and increase in spending that happens during a recession. It seemed obvious to me that that was merely political expediency, that they didn’t want to be charged with sacking doctors and teachers for example.

There exists only a limited amount of investment capital, the kind that is required to fund businesses and drive forward growth. Since the cause of the economic issues was fundamentally related to the debt markets, and banks in the Uk that have had financial issues have generally been over-exposed to the debt markets there currently exists a climate of irrational negativity with respect to investing in firms, and in general to spending money. The government’s monetary policy, the cutting of interest rates to their lowest rate ever, is an attempt to provide some disincentive to saving, and thus encourage spending and investment.

This all seems to ignore one critical aspect of the financial crisis that has been, in my opinion, heavily overlooked. When a flight to safety occurs, when investors look towards companies that are unlikely to go under during times of economic hardship, the British government’s bonds are always in demand. People already want to invest their money in buying government debt, because its comparatively safe, why encourage this trend? It crowds out the private sector from much needed funds, both in terms of medium term investment and short term spending. Given the size of the deficit during the coming two fiscal years, and the fact that someone has to buy the debt that is issued, there is a lot of money thats going to the public, rather than private sector.

One could argue that since the government are committed to injecting all the debt that they are accruing, via deficit, into the economy it actually isn’t something to worry about at all. Private sector companies are laying people off in ordering to save costs, whilst the public sector can simply plough on, injecting capital where it is needed. If one accepts this duality between debt and spending, however, it means that the net benefit of a government running a deficit is actually the different between its deficit and the amount of bond capital that wouldn’t have been investing in the economy, ie the amount that would normally be stored in some kind of savings account. Since we are currently bailing out banks because they lack these kind of funds … epic sigh.

So having thought about it a little more maybe we should be less gung-ho about using a fiscal stimulus in the current climate. Not that i believe that a fiscal stimulus is useless, but in a situation where there is a such a virulent flight to safety the effecting of crowding out the private sector could do more harm than good. Of course, interest rates have already reached their lowest level ever and can’t really help. I’m still somewhat uncertain as to how exactly demand is going to be stimulated by quantitive easing. To quote the great and wise Bender Bending Rodriguez, “We’re boned!”

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