Why the Stimulus Failed (well... one of the reasons!)

It is pretty much a fact that the most recent stimulus measures have failed. After a bust, there is a boom. The most recent recession was not followed by a boom. The government did attempt to create economic growth using fiscal stimulus—both Bush and Obama used stimulus measures in order to alleviate economic woes—but growth remains anemic even today. Although I am skeptical of stimulus spending in general, an interesting paper has been published by the Mercatus Center at GMU. The paper is titled “Why the Fiscal Multiplier is Likely Zero”.

The paper discusses why the modern stimulus package has failed to stimulate economic growth. He blames it on central banking. Specifically, a policy known as monetary offset.

I will use the same scenario the author uses. Say the Fed targets inflation at a modest 2%. Fiscal stimulus kicks in and causes prices to rise. If the inflation rate is already at 2%, the stimulus (forcing an increase in inflation) means inflation goes over the 2% limit. So the Fed has to contract the money supply in order to meet the 2% threshold. This prevents the stimulus from really creating anything—so the current stimulus was doomed to fail because of the Federal Reserve policies!

Now, I am a big proponent of the Federal Reserve. Well, maybe not—the jury is out. But I prefer it to a gold standard. The Fed should change their policies—as the author argues—in order to assume a moderate increase in spending. This would reduce the volatility created by the current system due to monetary offset and also lead to economic growth. Just in case a gold bug reads this blog, I should mention even the gold standard was 23 times *more* volatile than the current system.

So, now you know one of the reasons the stimulus package failed to create a recovery. It was the banks, not the stimulus itself (though… John Lott provides some interesting statistics saying the stimulus harms the economy anyway!)