Has a Stimulus Ever Been Necessary?

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One cannot
watch the news these days without being reminded of two things:
The economy is in recession and Barack Obama will soon be President.
One cannot listen to the latter without hearing that he will do
everything he can to save us from the former.

Can he, however,
actually do this?

and various politicians believe he can. At least they believe the
government, which he will soon lead, has the power to do so. The
Federal Reserve has preempted the president-elect with an expansionary
monetary policy via artificially low interest rates and the purchasing
of private assets. Obama and his supporters contend that they can
do more to spur economic growth. They claim that spending as much
money as possible will return the economy to prosperity.

Not surprisingly,
Congressional leaders, the media, and even a large swath of the
American public are encouraging this course of action. Congressional
Democrats hope to have a “stimulus package” prepared for Obama to
sign as soon as he is inaugurated. Supporters of this fiscal stimulus
contend that it will create jobs and encourage consumers to start
spending money.

At first blush,
it seems that both the government's fiscal and monetary remedies
are counterproductive. Pumping more money into the economy will
just reduce the value of money and lead to price inflation. Spending
money on government projects is just shifting money from one type
of spending to another. Government economists and most media commentators,
however, would respond that these objections are naïve.

Prior to the
Great Depression and the publication of John Maynard Keynes' General
, most economically knowledgeable people would have
agreed that government intervention is unhelpful if not detrimental.
Today, we ostensibly know better: Government intervention is imperative
to prevent economic downturns from turning into economic calamities.
Therefore, the Federal Reserve must inject liquidity into the economy,
and the government must actively combat unemployment and prop up

The theory
that underlies this policy approach holds that economic downturns
are the result of too little spending where overall (or aggregate)
demand for goods and services sharply declines. The government can
restore aggregate demand by running budget deficits (via increased
spending and/or lower taxes) and printing more money. This understanding
of economic downturns is too simplistic for and not universally
accepted by most (if not all) economists, but it has generally been
adopted by mainline politicians and the media.

Aside from
noting their general understanding of this already oversimplified
theory, the proponents of economic stimulus have failed to justify
exactly why it is so dire for the government to intervene in this
particular crisis. Even if the above theory is correct, why won't
the economy correct itself? The commentators, et al. are apparently
proposing that a stimulus package is a proven method for curing
a recession. History proves them wrong.

America, like
any capitalist nation, has gone through a number of boom and bust
periods. The number of economic downturns the nation has actually
experienced is not entirely clear. Different economists (and approaches
to economics) have different criteria for evaluating the business
cycle. (The National Bureau of Economic Research [NBER] keeps “official”
count.) Regardless of the number of actual recessions, there is
little evidence that any have been brought to an end by an economic
stimulus package.

As mentioned,
prior to the Great Depression, there was little support for the
government to pursue counter-cyclical economic policy. The laissez-faire
approach allowed the economy to return to prosperity by liquidating
mal-investments, shifting employment to more productive sectors,
and allowing the price level to drop. In the early 1920's, the nation
experienced a severe contraction after the end of World War I. There
is evidence that some in the government wanted to adopt a more interventionist
approach to the downturn, but the economy recovered (as it had in
the past) without any form of economic stimulus.

At the close
of the decade, the economy faced another economic contraction, but
this time, the government did intervene. Both Presidents Hoover
and Roosevelt pursued greater government control of the economy.
Most notably, President Roosevelt ran deficits to fund a number
of public works projects as part of his “New Deal.” Neither FDR's
domestic spending nor the later war brought America out of economic

of the New Deal disagree. They point to the economic expansion that
took place from 1933 to 1937, but this “expansion” was illusory.
While unemployment declined and government statistics indicate that
an expansion did take place, they hardly demonstrate that a genuine
recovery took place. For one thing, unemployment remained in the
double digits throughout the “expansion.” Moreover true economic
recovery and growth is associated with an increase in private business
activity — people return back to (mostly) private sector jobs, businesses
start growing again, consumers return to their usual spending habits,
etc. This was not the case in the 1930's.

The “expansion”
was illusory because it was not a return to normal business activity.
It merely reflected a growth in government spending. GDP takes into
account government spending, and the increase in employment was
primarily the result of government-created jobs. The New Deal did
not stimulate actual economic growth.

Even this pseudo-recovery
did not last for long as the economy fell back into a depression
in 1937. New Deal advocates insist that this was the fault of reduced
government spending. In part, they are correct because so much of
the “expansion” was merely a reflection of government expenditures.
The decline in government spending, however, did not retard private
commercial growth which, had never really recovered in the first
place. Even if this was a true recovery, Keynesian theory calls
for budget reductions during a period of expansion. Moreover, if
five years of government spending truly resulted in economic recovery
(as the New Dealers claim), it seems far-fetched to believe that
a slight retreat in the growth of the government would plunge the
economy back into a severe depression.

On the eve
of the Second World War, the economic situation was as gloomy as
it had been when FDR took office. Many historians and academics,
who may doubt the effectiveness of the New Deal, hold that it was
actually the War that lifted the nation out of the Depression. This
is also incorrect.

Like the New
Deal, US wartime production also created the illusion of prosperity.
Movie reels from the period depict shipyards and munitions factories
teeming with workers eager to produce weapons of war for the Cause
while young men donned uniforms and headed overseas to fight the
Axis threat. These images may appear to illustrate an economy on
the mend, but what they fail to display are the rationing, shortages,
and general dearth of consumer products during this period. The
increased employment was merely being directed towards serving the
needs of the state. Once again, this was not the true economic recovery
of the private sector that follows most recessions.

As the war
came to an end, the need for government spending declined. As economist
Robert Higgs observed, government spending fell from $98.4 billion
in 1945 to $33 billion in 1948. The government also abandoned a
number of New Deal policies in the post-War years. Despite this
“anti-stimulus,” the economy did not fall back into a severe depression
and instead finally returned to genuine prosperity.

The middle
part of the century also provides little evidence that economic
stimulus is necessary to pull the nation out of a recession. Despite
two recessions in the 1950's, the government did not propose the
active fiscal policy that had been pursued in the 1930's or that
is being proposed today. The government, in fact, even reduced expenditures
during the 1957 recession. In both cases, the economy recovered.

The 1960's
was a period of fairly consistent growth. Keynesians may attribute
this to the significant tax cuts and increased spending during the
decade. Tax rate reductions, however, not only have the effect of
encouraging spending, they also remove disincentives to production
and investment. Regardless, the policies of the 1960's were not
employed as countercyclical measure to lift the economy out of recession.

By the 1970's,
the nation was again facing serious economic challenges. Inflation
had become a serious concern. Despite the loose monetary policy
and significant government spending throughout the decade, the economy
faced a recession in the middle of the 70's and general economic
weakness throughout the rest of the decade — particularly with high
interest rates and inflation.

In the early
1980's, the Federal Reserve sought to combat inflation with a more
restrictive monetary policy. This plunged the economy into the most
severe recession since the Great Depression. The economy, however,
recovered without a stimulus package.

Advocates of
economic stimulus may argue that despite its professed pro-market
orientation, the Reagan administration actually did pursue an active
countercyclical economic policy. The administration did, in fact,
push through significant tax cuts while doing little to restrain
spending, which led to larger budget deficits.

This analysis,
however, ignores a number of points. For one thing, the Reagan administration's
fiscal policy coincided with a restrictive monetary policy. Keynesian
economists at the time likened this to stepping on the gas and the
breaks at the same time. Furthermore, Keynesians were also fairly
critical of the tax cuts because upper income people (who benefit
the most from income tax reductions) are less likely to spend their
tax savings than lower income individuals. Moreover, many politicians
and others (much like today) urged President Reagan to pursue a
stimulus package of public works and public “investment” to combat
the recession. The President rejected these pleas.

If Reagan was
an accidental Keynesian, his successors were incidental anti-Keynesians.
In the early 1990's, the economy fell into a minor recession. It
is true that the recession coincided with a tighter monetary policy,
a tax hike, and even a slight retreat in military spending as the
Cold War came to an end.

The Clinton
administration, however, did not respond with an expansionary economic
policy. The new administration raised taxes, further curtailed military
spending, and sought to remedy the large deficits it had inherited.
It is true that President Clinton pursued an economic stimulus package
and a proposal for government-managed health care, but both initiatives
were defeated by the Congress. Clearly, this tightfisted (at least
by today's pessimistic standards) approach to fiscal policy did
not impede recovery.

Soon after
the (now outgoing) Bush administration took office, the nation faced
yet another recession. The current administration did take a more
active role during the downturn than some of its predecessors. It
cut tax rates, issued rebate checks, and extended unemployment benefits.
Nonetheless, none of these measures resembled the type of spending
advocated by the incoming administration for dealing with the current

Today, of course,
we hear little but cries for economic stimulus in order to prevent
the next Great Depression. Not only is the President-Elect ignoring
the economic history of the United States, he's also ignoring the
reigning policy of the past few years. The government has essentially
run consistent deficits ever since President Bush took office. The
current administration has executed two wars, created a homeland
security cartel, and has been responsible for a slew of new domestic
spending initiatives. It has done all this while the central bank
has continued to ease its monetary policy. It is difficult to contend
that the government has not done enough to prop up artificial demand.

The fallacy
behind the call for economic stimulus is that declining aggregate
demand is the mother and not the daughter of economic contraction.
When left to its own devices, the market will return back to prosperity
(consumer demand and all). Government intervention oftentimes has
the effect of actually prolonging the crisis. The new administration
would be wise to let the market adjust on its own and spare us the
additional debt and debased currency that an active fiscal and monetary
policy will yield.

15, 2009

Rosen [send him mail] is
a law student at the Villanova University School of Law.

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