Measures Taken by US Government to Stimulate Economy are Illusionary: Professor of Economy of French University

Business Materials 28 November 2008 15:24 (UTC +04:00)

Azerbaijan, Baku, November 28/ Trend /

Pascal Salin, Professor of economics at University Paris-Dauphine and former President of Mont Pelerin Society, especially for Trend .

Given the fact that the financial crisis is now becoming also an economic crisis, which means that there is a slowing down of economic activity in many countries, many governments consider that they have to stimulate economic activity by launching stimulus packages. Such is the case of the president elect of the US, Barack Obama. Before going a little more in detail through his package, let us first have a general view about these stimulus packages. My firm opinion is that they are purely illusory. In fact, all of them are inspired by some vague prejudices inherited from the Keynesian tradition according to which, whenever there is a slowing economic activity, governments have to increase total demand in order to induce producers to produce more. Among the traditional instruments there is the budget deficit (public demand), an increase in exports or investment, or even a stimulus given to consumption at the expense of savings. There would be much to say about the errors of this Keynesian approach. But let us just stress for the time being that the problem to be solved - if ever it can be solved - is not a problem of a lack of total demand. To understand that, one has to consider the cause of the present criris, since it would be foolish to try to solve a problem without knowing its cause.

Now, the main cause of the present situation comes from the fact American monetary authorities have created too much money by imposing a low interest rate between 2002 and 2006. Therefore, investors have been inclined to decide investments which were in fact non-profitable (except at the artificially low interest rates which prevailed). Thus, there have been a lot of distortions in the system of production. The problem is not a global problem, it is a sectoral problem. Therefore, the only solution consists in letting markets adjust to a more normal situation, in particular by letting firms which have been particularly badly managed to go bankrupt, so that their assets are re-purchased by more efficient owners and managers. This process of adjustment is costly and it would have been better not to have to go through it (which would have been the case with a less destabilizing monetary policy). But we cannot rebuild the past...

Stimulus packages are not addressing the right problem and there is a high probability that they will only slow down the process of adjustment done by markets. From this point of view, one has to be anxious when considering that the Fed has already decided to decrease its target for the federal funds rate at an incredible low level of 1%, thus creating the risk of a new cycle of low interest rates, excess money balances and bad investments.

As regards the Barack plan more precisely, all its features are not yet well known. But it seems that it implies increased public expenditures, for instance to bail out firms (such as financial firms or car producers, although the American public opinion does not completely agree on this) and tax cuts. The increased deficit will shift scarce resource from private investments towards the arbitrary financing of some big public projects which are decided more just to spend the money (under the pretext of stimulating total demand) than because of their own merits. Public expenditures - either financed by debt or by taxes - do not create new wealth; they just take wealth created by individuals from them in order to use it to purchase other goods arbitrarily chosen by politicians and bureaucrats. In that sens there is no stimulus effect, but quite the reverse and the Obama package - as well as all other present packages - ought to be called "package for slump". As regards the tax cuts, Barack Obama promised to decrease the income tax for 95 % of American people, which is good (if ever he can succeed to do it). But it is good not because it is supposed to increase consumption - since growth needs capital accumulation, i.e. savings and not consumption - but because it creates incentives for people to work more, to save more, to hire more wage-earners, etc... Unhappily Barack Obama intends to increase marginal tax rates on high incomes. As all experiments, all over the world, has clearly shown in recent years, whenever one increases these rates, there is a slowing down of economic activity. The reason is that, in any society, all people are inter-dependent: If ever, you create a disincentive for an entrepreneur to invest and to create new jobs, there will be a lower rate of growth and a higher rate of unemployment.

In short the best stimulus policy would be to let the markets make the necessary adjustments.

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