How to make a stimulus stimulating

Tuesday 13th December 2011

Here’s an interesting video on why the American stimulus has pretty much failed to do what it was designed to do:

I’m not going to claim that it definitively explains why the stimulus didn’t work. As far as I can tell it was made by a libertarian think-tank – so possibly some bias there – and it really only gives anecdotal evidence. Nevertheless I think it’s objectively fair to say that the American stimulus did fail, that we know that governments aren’t very good at spending money efficiently*, and so at the very least the explanation that is given in the video is plausible.

For the sake of argument, let’s assume that a stimulus was the right response for America in 2009, and that the problem was that the money wasn’t spent very well. Well, surely a more sensible approach would’ve been to use the stimulus money to lower taxes? Increasing the personal allowance on income tax (assuming they have this in America; I know it works differently because of State and Federal governments) seems like one reasonable way to do this, which would be pretty progressive too I imagine. Take less money from people so that they have more to spend, because people tend to spend money more usefully than governments do.

I suppose that it’s possible that the actual result might have been that people would’ve paid back some of their debts, rather than spend more money. I’m not sure if that would necessarily be a bad thing, but I guess it’d detract from the actual aim (to quickly stimulate growth). But if that’s true, it doesn’t necessarily follow that tax cuts would be less effective at stimulating growth than extra government spending was. And I think it’s pretty certain that if people used tax rebates to pay off debt, it’d do much less damage than does wasted government spending. If the stimulus is used to pay back debt, then we can probably think of it as a “deferred” stimulus; debt is paid off now, so that people can spend more in the future.

I’d like to make clear that I don’t necessarily think this is what the American government (or the British, for that matter) should’ve done. Fundamentally, I think that the economy would’ve been in a better situation in taxes and government spending were generally lower, particularly in the boom years. And I’m not really a fan of Keynesian economics in general (it seems way too full of magical thinking for my taste). But if we decide that a stimulus is a good idea, then it seems to me that cutting taxation – taking less money from people when times are tough – would be much more effective.

I do wonder why so few Keynesians seem to advocate this course of action though…

I realise that lately I’ve tended to write lots about economics and finance and politics. Mostly that’s because it’s topical and I find it interesting, and because I’m learning about this stuff and writing about it is a good way for me to get things clear in my mind. If I write something, I like to be pretty sure that it’s accurate, so I end up going away and reading lots more. Today I’ve been learning about how fractional reserve banking works (which is rather less intuitive than I thought), so I guess this entry could’ve been even drier…

Anyway. My next blog post will probably be about aeroplanes.

* Lots of studies (for example) which have compared growth rates and tax rates in different countries show that there’s a negative relationship between the rate of tax (and thus the size of government) and growth rate (i.e. bigger government leads to less growth and poorer people). I did read one interesting paper recently (which I now can’t find) which found that up to a point, an increase in government increases growth. But that above a (comparatively low) level, the relationship is negative. That kinda makes sense; government is useful for some things. A country with a small government which – for example – just maintains the rule of law (i.e. provides courts, police etc) might be expected to have more growth than a country that doesn’t have these things. The trick is finding those things that the government can genuinely deliver efficiently, and stopping it from doing other stuff (in practise, it’s easy for politicians to pander to special interests; its a good vote winner).

Posted at 11:32 pm | Posted In: Politics Tagged:

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