Wednesday, February 18, 2009

Stimulus Package

I'll keep this as brief as possible since it's getting close to my bed time, but here's why I think the economic stimulus package won't work. I'll start with the most obvious observation which is that the government has been spending money like crazy and running up the deficit for the last several years and if that hasn't worked, why would anyone really expect that increasing government spending even more would suddenly start working now? I contend that runaway spending is one of the factors contributing to getting us in the mess we're currently in. To finance all of the spending, the government has in large part just printed up more money without any kind of backing. This has led to a severe devaluation of the dollar. This has effectively meant salary decreases for everyone in the nation, not to mention decreased profitability for businesses. When your dollar doesn't buy as much as it used to, consumer spending will decrease, which means greater decreases in profitability for businesses, which leads to layoffs, which leads to further decreases in consumer spending, etc. It's a vicious downward spiral that isn't going to end by further devaluing the dollar.

The prevailing public opinion is that the New Deal is the model of how the government can spend it's way out of a depression or recession. The truth is that the New Deal implemented new government spending programs from 1933-1938 and the economy didn't start it's recovery until late in 1941 when WWII started. FDR was in office for 8 years before the economy turned around, and the New Deal programs were ineffective. The evidence suggests that we're more likely to turn the economy by starting another war than by more government spending programs.

Most of the philosophy that increased government spending and decreased interest rates is the way to fix a depressed economy comes from John Maynard Keynes. Since I haven't taken any economics courses since college about 15 years ago, I decided to brush up on my Keynesian Economics. A lot of the theories are logical, but the two factors which I think are noteworthy are that government spending crowds out investment from the private sector, increasing the nations reliance on the government and making it more difficult for the private sector to sustain itself. Second, increasing the deficit increases the volume of government bonds, decreasing their value and encouraging an increase in interest rates. This makes it more expensive for businesses to finance investments.

I don't really know what the solution is, but I don't think the economic stimulus package is it. I think that fiscal responsibility by both the government and individuals is important, and ultimately investor confidence is going to have to return somehow before things start to improve.
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