A Rebuttal Of The Case For Fiscal Stimulus

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by: Jeremy Robson


There are calls from multiple financial participants for fiscal stimulus.

As monetary policy is proving unsuccessful we need to 'up the ante' and go for fiscal deficits.

Many participants are talking the equivalent of Mr Bernanke's helicopter money. Fiscal deficits monetized by the central bank.

I have just read this article by Cullen Roche. It is symptomatic of many similar calls for larger fiscal deficits. Bill Gross just called for more deficit spending (link). I am sure that you have heard or read something similar recently.

It is becoming clearer that monetary policy is falling short of getting the economy back to the growth rates of previous periods. This is the poorest economic cycle on record for growth and it is getting long in the tooth. There is a whiff of panic in the air. What happens now? Money mangers are desperate. What story do they tell their clients? If zero interest rates and QE are producing low growth, how do we sell our services for the next 10 years. Buy and hold does not look so good, if the economy is barely growing. The easy solution is to promote fiscal largesse, hopefully monetized by the Federal Reserve. Problem solved. The world goes on, Wall Street is happy and takes it's fees into perpetuity.

So what about the problems associated with fiscal deficits (the ones that you rarely hear about). Well here are a few,

1. The employment rate is 4.9%. If infrastructure spending is the chosen route, the government will start crowding out the private sector and wages will start to rise. Inflation increases and what do we do next? Either ignore it or raise interest rates. Ops, raising interest rates will slow the economy!

2. The government is always wasteful. Larger deficits mean greater waste.

3. In the United kingdom, the government recently tried to take away some benefits to people in work on lower salaries. There was an outcry and a rebellion by the lower chamber of Parliament. The upshot is that the benefits have been restored. It must be clear by now to everyone with any intelligence, that spending on benefits can never be taken away. If you start the benefit, it can never practically be withdrawn. This leaves the economy more reliant on the public sector than previously and reduces incentives for the private sector to outperform.

4. Apparently, fiscal deficit spending can be withdrawn at any time. After all, the U.S. has now got it's deficit back to 3% of GDP, from a peak of over 10%. However there is now a call for higher deficits, so the reduction is only temporary. I would argue that if we go down the fiscal deficit route to solve a low growth problem, the deficits will be permanent and growing. This is the conclusion from the Japanese experiment. I cannot see the U.S. being any different. This is the heart of the problem of fiscal deficit spending to cure low growth. The solution looks easy but it is pernicious. It slowly but surely becomes the only way to produce growth.

5. Let's reduce taxes and the economy will grow faster. No more productivity, just greater spending to juice growth. In the long run growth only comes from greater productivity and/or an increase in the population. That is economics for beginners, but neither of the above is increased by lower taxes. The stimulus will not therefore be a permanent solution, just a temporary reprieve.

The graph below shows the growth rate of the U.S. economy,

As you can see growth peaked in 1979-80 and has been on a downward trajectory ever since. Government debt to GDP was 32% in 1980, it is now 101% (link). It seems pretty clear to me, history is telling us (without any ifs or buts) that the increase in public debt is not producing higher levels of growth. Why on earth is anyone suggesting that this is the solution we should try. We all know the Albert Einstein quote.

Please don't get me wrong, I am not suggesting that there is no problem to solve here. I am just suggesting that fiscal deficits combined with monetization is not the solution. I wonder when sanity will return to economic solutions for our present malaise. As Wall Street and money managers have such a large influence in policy making, it may be a long time. God help us!

Disclaimer - This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.