This is my entry to Nick Rowe’s challenge to come up with a model demonstrating the damages of fiscal stimulus. The belief in government stimulus requires us to believe the previous level of demand is sustainable, desirable and not declining for some fundamental reason. That isn’t necessarily a question of economics, you can’t plot culture on a chart. If people were comfortable in previous decades living with more debt-based consumption and a bias towards equities instead of savings, but the culture changes and people are no longer comfortable with that formula, the economy has changed for a very real and fundamental reason. If people want less, why should the government force feed us things we don’t want? If people are determined to save and the government threatens to destroy savings (with negative interest rates or some other stupid ideas) people will simply find alternate means to save. Maybe they will hoard food or gold and cause other problems like shortages and hunger.
In order to understand how I see the world, you must come to the conclusion (as I have) that many businesses currently “idle” should never have existed in the first place, they only exist because demand has been skewed by years (or decades) of government interference and stimulus of other forms (including monetary). Each time the government intervenes these businesses become more convinced of their soundness, but in reality it was always an illusion from the beginning, they are addicted to government heroin. These businesses are like an infection, the infection wants to live, it wants to grow and thrive, but it damages the body (the economy) and survives by consuming resources other beneficial cells could have used more productively. If our immune system (the market) attacks the infection or takes away its resources, we shouldn’t complain that it’s idle, we should let it die. The process of killing it isn’t fun, we could get a fever and a headache and feel like crap (recession) but ultimately we emerge stronger without that weight holding us down. A business that consumes resources and loses money makes the whole country poorer.
The economic argument is basically Hayek’s argument that interest rates are not an arbitrary number, but serve a coordinating function in the economy. It’s a signal to producers about the relative willingess of people to consume today or in the future. When people save, the cost of capital goes down and long term projects become economic. When people spend, cost of capital increases and businesses can only get funding for short term projects intended to meet current demand. When both long term and short term projects are economic at the same time (low interest rates, stimulus) we get booms that inevitably lead to excess capacity and busts. The bust is not the problem, the boom is the problem. The government stimulus argument says we must create demand to fill the capacity. The Austrian argument is the capacity should never have been created in the first place and must be liquidated for mis-allocated resources to be freed for more productive purposes. Each time we strap on another bandaid the more infections survive the bust and the larger the imbalances ultimately become. The transition is painful, but the longer we delay the restructuring the greater the pain will be. It’s just a matter of time. Again, excluding the potential of game changing miracles (like cold fusion or something).
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