Ignored cost of stimulus negated any benefits

Published in The Tennessean, Sunday, July 10, 2011

by Richard J. Grant

One reason that big government is associated with weak economies is its inability to consider adequately the costs of its actions. This is why the various “stimulus” packages have failed to achieve their stated goals. They did succeed in bailing-out particular companies and classes of investors, but the American economy has been slow to adjust and is showing signs of continued weakness.

Big-spending governments can always point to big results. But these results look good only when some of the costs are ignored. When the federal government spent hundreds of billions of dollars specifically on “stimulus,” the burden on taxpayers and the private sector was greater than that. Taxpayers hand over the levied amount of dollars to the government, but they also bear the burden of tax-compliance costs and the adjustments to maximize after-tax profits.

That is just fiscal policy – the effects of government spending, taxing, and borrowing. But monetary policy is also a tool of first resort in stimulus efforts. Control of the money supply gives influence over the level of interest rates and asset prices.

The power to create base money gives the Federal Reserve the ability to increase liquidity and hold down interest rates. Since mid-2008 the Fed has tripled the quantity of base money, an increase of almost $2 trillion. Its stated intention is to reduce the cost of borrowing and to encourage the purchase of big-ticket items such as cars, houses, and appliances.

Policymakers also quietly hope that the resulting weakness in the dollar relative to other currencies will make American-made goods appear cheaper to foreign buyers while making foreign goods more expensive to Americans. The goal is to encourage exports while discouraging imports in order to create a greater demand for American-made goods.

The Fed buys bonds with newly created money. This bids up the prices of the bonds and reduces their interest rates. Seeking higher returns, many investors switch to the stock market, thereby bidding up stock prices. With bond and stock prices rising, the experience of increased wealth induces many investors to spend more.

Policymakers hope that all this will stimulate production and employment. But they seem to ignore the burden borne by those, especially seniors, who are dependent on income from low-risk interest payments. Fed policy has severely reduced their incomes below what they would have received in a normal post-recession recovery.

Such income reductions have real effects on the economy. Recently published estimates by William F. Ford, a professor of finance at Middle Tennessee State University and former president of the Federal Reserve Bank of Atlanta, and Polina Vlasenko, a research fellow at the American Institute for Economic Research, show reductions in consumption, gross domestic product, and employment that more than cancel out even the most generous claims on behalf of the fiscal stimulus.

By their most conservative estimate for 2010, Ford and Vlasenko found that the Fed's artificially low interest rates caused “$256 billion of lost consumption, a 1.75 percent loss of GDP, and about 2.4 million fewer jobs.” Had these jobs not been lost, the May unemployment rate would have been 7.5 percent instead of 9.1 percent.

When they include more assets in their calculations, the adverse impact of the low-interest-rate policies on employment can be almost double the conservative estimate. Perhaps this helps explain why neither fiscal nor monetary stimulus policies really work.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

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