Another Stimulus

Federal Reserve Chairman Ben Bernanke said yesterday that “consideration of a fiscal package by the Congress at this juncture seems appropriate”. President Bush is open to the idea, and Nancy Pelosi is chomping at the bit to pass it during the lame duck session after the election. It is almost certain the pass, and the size I have seen tossed around is $300 Billion.

What will the stimulus do?

I will assume for now that the stimulus is once again a simple mail out of checks. I have heard of other spending possibilities, but it has all been rather vague. Even some free market types who have not completed their Jedi training, would have you believe that all we are doing is borrowing future growth for present growth. The costs, they believe, are small to reduce the hardship of recession.

However, there is an additional problem with the “stimulus” that reveals that it will do nothing to help the economy, just like the first “stimulus”. To pay for it, the government will have to borrow funds from the capital market. To induce private holders of capital to loan money to the government they have to increase interest rates to gain a larger share of the capital market. This increased demand on capital causes all interest rates to rise as people and their businesses compete for the limited supply of capital. An increase in the real interest rate makes the rate of return on business investments lower, and thus fewer private business deals happen. In short, less economic growth in the private sector offsets the increase in the economic growth in the public sector.

In general, the stimulus will be a net drag on the economy. It’s really a stretch to believe that forgoing long-term business investments in hopes that individuals will profligately gobble up our limited resources is good for the economy. Don’t gripe at AIG for spending precious funds on spa treatments for sales reps, when your economic plan relies on Americans doing the exact same thing.