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Easy Money's Making Things Worse

Why does Obama think this particular stimulus will work...?

THE MAJORITY of experts think that still-subdued economic activity requires a more aggressive stance from policy makers in order to revive the economy, writes Frank Shostak for the Cobden Centre.

Since the end of 2007 the Federal Reserve pumped about $2 trillion into the banking system while the US central bank policy rate – the federal funds rate target – was lowered from 4.25% in December 2007 to 0.25% at present.

A week ago US President Obama suggested a $450 billion stimulus package to revive the economy. Observe that in February 2009 the Congress had approved Obama's first stimulus package of $787 billion. 

Despite all the aggressive measures taken by the Fed and the US government the economy remains depressed. Since the approval of the first fiscal stimulus package almost 2 million jobs were lost. While since the end of December 2007, when the aggressive pumping by the Fed was introduced, almost 7 million jobs have disappeared. The unemployment rate has jumped from 5% in December 2007 to 9.1% in August this year.

Why then should Obama's additional fiscal stimulus package and more aggressive Fed pumping revive the economy? The experts are of the view that given the lack of positive response by the US economy to all the fiscal and monetary stimulatory policies, it implies that the economy has strongly deviated from the path of balanced economic growth. 

On this way of thinking the economy is seen as some kind of space ship that has deviated from its trajectory. To bring it back onto the correct path policy makers must give it an external push. So if the first push in terms of loose monetary and fiscal policies didn't produce the required results then policy makers must become more aggressive until the space ship is brought onto the correct growth path.

The purpose of production is to generate final consumer goods and services that maintain and improve individuals' life and well-being. Various means are employed for this such as tools and machinery and labor. All these resources whilst important are not sufficient.

What is required is an adequate pool of final consumer goods and services that will maintain the life and well beings of individuals engaged in various stages of production that range from the production of final consumer goods and services to the production of tools and machinery i.e. capital goods. It is the pool of final consumer goods and services that funds various activities. The size of this pool dictates the type of activities that can be undertaken.

For instance, if the size of the pool permits the building of a very basic tool then the building of more advanced machinery cannot be undertaken, notwithstanding the plentiful of natural resources, technological knowhow and skilled labor.

In order to be able to make more advanced machinery individuals, instead of consuming existent produced final goods, would have to save a portion of these goods and allocate them towards the enhancement and the expansion of tools and machinery. With better tools i.e. capital goods, a greater production of final consumer goods can be undertaken, which in turn will permit the making of a more sophisticated infrastructure.

Note that any form of economic activity must be funded by means of final consumer goods and services. Neither the government nor the Fed have the ability to generate final consumer goods to fund the building and the enhancement of infrastructure.

For instance when the Fed pushes more money to the economy all it is doing is increasing the amount of the means of exchange. An increase in money supply sets in motion an exchange of nothing for something i.e. it diverts final consumer goods or wealth from wealth generating activities towards non-wealth generating activities. This in turn undermines rather than strengthens the economy's ability to expand real wealth. (It is exactly the same outcome produced by a counterfeiter).

Likewise loose fiscal policies produce the same results as printing money does – it diverts wealth from wealth generators to non-wealth generating projects. What then is the point of trying to boost employment by means of loose fiscal policies, which in the process weakens the economy's ability to generate more wealth (such as digging ditches and making pyramids)?

Once the central bank tightens its stance for whatever reasons the diversion of wealth to non-productive activities stops and various useless projects must be aborted. Obviously various individuals employed in these projects become unemployed.

It is true that now we have idle resources. Contrary to popular thinking the employment of idle resources with the help of loose policies is not cost-free, this requires the diversion of wealth from wealth generating activities.

Also, it is false that loose fiscal and monetary policies are required to fix the unemployment and revive the economy.

Remember that loose policies only weaken the ability to generate wealth. Obviously then we require less and not more of these policies to grow the economy.

A better alternative is to curtail the ability of the Fed and the government to engage in aggressive loose policies. This will leave more wealth in the hands of wealth generators and will enable them to get on with the job of setting in motion true economic growth.

With the expansion in the production of wealth, all other things being equal, a greater demand for resources including labor will ensue. In short more wealth will make it easier to absorb so called idle resources.

Despite aggressive fiscal and monetary policies the US economy remains subdued. Since December 2007 almost 7 million jobs have disappeared. Experts, however, are of the view that a more aggressive monetary and fiscal stance is required to revive the US economy. We suggest that loose monetary and fiscal stance will only further damage the foundations of the economy.

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Built on anti-Corn Law radical Richard Cobden's vision that "Peace will come to earth when the people have more to do with each other and governments less," the Cobden Centre promotes sound scholarship on honest money and free trade. Chaired by Toby Baxendale, founder of the Hayek Visiting Teaching Fellowship Program at the London School of Economics, the Cobden Centre brings together economists, businesspeople and finance professionals to better help these ideas influence policy.

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