Inappropriate Stimulation
March 8, 2009
by Mario Rizzo
Paul Krugman continues to say on his blog that the fiscal stimulus was too small. After all, unemployment is rising quickly:
“[I]t’s rapidly becoming clear that yes, the plan was too small.”
Brad DeLong has also added his voice to the call for bigger stimulus, again largely because of the deteriorating employment picture. He also instructs those who disagree with him as to which objections to stimulus are reasonable. (The one I raise here is not included.)
However, Krugman and DeLong’s inferences are superficial. If we look more carefully at what is going on we see that macro stimulus is designed to hit precisely the wrong targets. The problem is not size but appropriateness.
Let’s look at a report in Krugman’s own host newspaper, The New York Times, “Job Losses Hint At Vast Remaking of the U.S. Economy,” that goes beneath the aggregate picture:
“As government data revealed that 651,000 more jobs disappeared in February, a sense took hold that growing joblessness may reflect a wrenching restructuring of the American economy.”
As we now know, job losses have been far greater than average in construction. But financial services, American automobiles, retailing (based on consumer credit), computer services, technical consulting, research and development and other areas dependent directly or indirectly on cheap credit have also lost jobs.
“This rapid deterioration [in employment] has prompted talk that some industries are being partly dismantled.”
What is happening is a massive re-allocation of resources mainly due to the excessively low interest rate policy of the past few years – but also partly due to certain sectoral shifts. The American car manufacturers, for example, are suffering both from the contraction in credit and from their own long-term inefficiencies.
The fiscal stimulus program is designed to stimulate where economic activity has deteriorated and there are job losses. Many of these areas are those that had over-expanded. As we have been saying for some time on the blog, the effect of this kind of stimulation is to slow down the re-allocation of resources. It will not succeed, however, in preventing it. What it will do is prolong the recession.
There is no denying that some areas of economic activity are depressed simply because of overall pessimism and fear, including among lenders. This is reflected in the widespread diffusion of job losses.
These areas do not need to contract in the long run. Yet planners do not have the knowledge to know exactly which ones are in this category. The way to dissipate the general pessimism, for example, is to prevent outright deflation (which is not in sight) and to allow individual markets to equilibrate quickly. Delay causes uncertainty.
The necessary re-allocation of resources that must be a part of any recovery should not be hampered in the name of aggregate stimulus. The neglect of issues such as this is why the crass “Keynesianism” that is being peddled in the media and by those who should know better is grossly inadequate to the solution of our economic problems.
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