Inappropriate Stimulation


by Mario Rizzo


Paul Krugman continues to say on his blog that the fiscal stimulus was too small. After all, unemployment is rising quickly:


“[I]t’s rapidly becoming clear that yes, the plan was too small.”


Brad DeLong has also added his voice to the call for bigger stimulus, again largely because of the deteriorating employment picture. He also instructs those who disagree with him as to which objections to stimulus are reasonable. (The one I raise here is not included.)


However, Krugman and DeLong’s inferences are superficial. If we look more carefully at what is going on we see that macro stimulus is designed to hit precisely the wrong targets. The problem is not size but appropriateness.


Let’s look at a report in Krugman’s own host newspaper, The New York Times, “Job Losses Hint At Vast Remaking of the U.S. Economy,” that goes beneath the aggregate picture:   

“As government data revealed that 651,000 more jobs disappeared in February, a sense took hold that growing joblessness may reflect a wrenching restructuring of the American economy.”


As we now know, job losses have been far greater than average in construction. But financial services, American automobiles, retailing (based on consumer credit), computer services, technical consulting, research and development and other areas dependent directly or indirectly on cheap credit have also lost jobs.


“This rapid deterioration [in employment] has prompted talk that some industries are being partly dismantled.”


What is happening is a massive re-allocation of resources mainly due to the excessively low interest rate policy of the past few years – but also partly due to certain sectoral shifts. The American car manufacturers, for example, are suffering both from the contraction in credit and from their own long-term inefficiencies.


The fiscal stimulus program is designed to stimulate where economic activity has deteriorated and there are job losses. Many of these areas are those that had over-expanded. As we have been saying for some time on the blog, the effect of this kind of stimulation is to slow down the re-allocation of resources. It will not succeed, however, in preventing it. What it will do is prolong the recession.


There is no denying that some areas of economic activity are depressed simply because of overall pessimism and fear, including among lenders. This is reflected in the widespread diffusion of job losses.


These areas do not need to contract in the long run. Yet planners do not have the knowledge to know exactly which ones are in this category. The way to dissipate the general pessimism, for example, is to prevent outright deflation (which is not in sight) and to allow individual markets to equilibrate quickly. Delay causes uncertainty.


The necessary re-allocation of resources that must be a part of any recovery should not be hampered in the name of aggregate stimulus. The neglect of issues such as this is why the crass “Keynesianism” that is being peddled in the media and by those who should know better is grossly inadequate to the solution of our economic problems.


Related Posts


Why Obama’s Stimulus Won’t Work


The Stimulus is Too Small











28 thoughts on “Inappropriate Stimulation

  1. A fine post. Let me add a footnote. In addition to the fact that “the fiscal stimulus is designed to stimulate where economic activity has deteriorated and there are job losses,” some of it is designed to subsidize actions that are uneconomic by any reasonable market test of profit and loss.
    A case in point is highlighted by The Economist’s briefing, “Carbon Capture and Storage,” March 7, pp. 74-75. The article mentions that $3.4 billion of the stimulus is targeted for a carbon capture and storage program, even though numerous energy experts and utility executives point out that it can’t possibly be anywhere near profitable.
    Indeed, Al Gore (yes, that Al Gore), who is described as “America’s green conscience,” says it won’t work in either the short or medium term. Greenpeace says it will never work and is not alone in this opinion.

    I get the impression from reading Krugman and his fellow Keynesians that they just don’t understand basic microeconomics, and ideas such as the economic function of profit and losss. I shudder to think what they teach undergraduates in microeconomics courses.
    Profits and capitalists are evil, maybe?

  2. Wow. I get it. Capital Structure.

    Or should I say <a href=””I already got it.:

    “The other serious problem I have concerns capital theory and its place in nature of trade cycles. Output has fallen and production has fallen because there are serious misallocations of capital that have accumulated over the past few years and we now have capital allocated in very poor structures which the market is now reacting to. The Keynesian will say that output has fallen because people aren’t spending enough which is hurting aggregate demand and enabling the harmful paradox of thrift. The idea here is that everyone’s spending is someone else’s income. Again, that may seem true but it misses the larger point of what is happening in a system of exchange.

    Capital is not play dough. It cannot be simply or quickly reformed and reshaped into something useful and sustainable. If there is too much capital and labor misallocated in, say, construction, then we have a problem. And we also have a problem with all the related or subordinate capital that is structured around it in multiple layers.

    Think of de-fragging your computer. When you hit “defrag”, there are many blocks that start to get moved and replaced. That’s what a recession is. Capital is like leggos, not play dough. the blocks must come apart and find better uses and put back together different according to dispersed information. And it’s painful in the process.

    What the stimulus does is ignore all of this. It simply feels that spending must be propped up and idle/underused resources put to use to start the multiplier effect to get output back to where it was. It never questions whether that is a good idea or why these resources are idle in the first place beyond the observation that spending is low. That is simplistic and simply insufficient as a foundation. It ignores heterogeneity of capital. IOW, capital and labor are NOT homogeneous.

    When confronted with these complex concerns of massive capital misallocations intertwined is a myriad of mind-boggling ways and their effects on the economy, the pro-stimulus Keynesian simply cannot be bothered. Their models don’t have the depth or capacity to wonder about or question such complex detail. It is dismissed.

    Never mind why output down…it’s a matter that output is down and must be propped up.

    Does that make me an economist? 😉

    …even though I’m not. (?)



    I may not know much about advanced economics and Krugman and DeLong have surly forgotten more than I’ll ever know about economic science and its many branching arms of specialization from econometrics to behavioral economics and on and on…but I don’t see how any of that allows them or anyone else to side-step this idea of heterogeneous leggo-like capital allocation.

    You don’t need to be a PhD in Economics to know what a daunting challenge this idea poses to the logic of stimulus spending.

    I’d rather see the government quadruple unemployment benefits to help the displaced instead of clumsily tampering with the very fibers of economic activity at capital allocation level.

  3. Stimulus that probably would do the trick: immediately cease taxing dividends and interest income. Credit markets would have the loanable funds they need [because apparently the ‘experts’ say it’s frozen] and the savings rate [and all the handwringing associated with its low levels] disappears.

  4. Excellent post and I agree. Yet, I think you left us hanging a bit on what the right solution(s) should be to address our problem. Is it basically to get out of the way and let the chips fall where they may on the way to equilibrium? Ok, but that’s probably not politically feasible, so what are the policy moves that would be most beneficial here?

    I’d love to hear more of your thoughts on this.

  5. John V posits the existence of “the logic of stimulus spending.” I say there is none. Doesn’t take much study of (Austrian) economics to realize that stimulus spending cannot be known to be useful in advance. Some might be helpful; some might be harmful; but you can be sure that with transaction costs, it will be on the whole harmful.

    So why are these idiots doing it? Don’t they understand that they’re playing with fire?

  6. “The way to dissipate the general pessimism, for example, is to prevent outright deflation (which is not in sight)”

    Does this mean that you support the Friedman/Bernanke view that the money supply should be expanded aggressively during a recession/depression? Because even if Keynesians are wrong in a very stupid way, monetary manipulations is in my view only wrong in a slightly less retarded way.

  7. […] Inappropriate Stimulation « ThinkMarkets The fiscal stimulus program is designed to stimulate where economic activity has deteriorated and there are job losses. Many of these areas are those that had over-expanded. As we have been saying for some time on the blog, the effect of this kind of stimulation is to slow down the re-allocation of resources. It will not succeed, however, in preventing it. What it will do is prolong the recession. […]

  8. This seems right on, but it should be noted that some of the stimulus will be used in areas where too few resources have been allocated in the past twenty years: education, infrastructure, and “green” technology.

  9. Cargo Cult Economics

    Government spenders and casual observers see personal and business spending, and the associated employment and prosperity. They come to the wrong conclusion: that the spending created the prosperity.

    Sad to say, this is a type of Cargo Cult centered around money. John Maynard Keynes is the shaman of this cult.

    Stimulus would be great, except the government which promises to spend money is also promising to take that money away from the peole who are already spending and investing. No investment or asset is safe from the government, so people are not risking their effort and savings.

    The economy is bad because no one can predict the future with a big government elephant stomping around. The elephant can’t solve the problem, and it scares away the elves who can solve the problem. The elves are small, but they are smart and there are a lot of them.

  10. Is that “Stimulus” as in the stimulus Chrais Matthews gets running down his leg when he hears Obama read from a teleprompter?

    And, how can anyone trust anyone from The New York Slime. Isn’t that the oh, so intelligent paper that they had to borrow $250 million from a Mexican “Financier (Drug lord?) at 14% interest? Can The New York Slime spell “usury?”

  11. I’d like to repost a comment I made at Clive Crook’s site:

    I have seen the “shortfall in demand” — which I take to mean the difference between 2009 demand and the production capacity of a “healthy” economy — used as justification for a larger stimulus package in a couple of places now, and I am fairly certain that it is a mistake.

    Suppose a stimulus was sufficient to make up this shortfall; i.e., to temporarily restore aggregate demand to its pre-recession level. Then the basket of goods we are capable of producing could all be consumed. But in many categories we are producing too much!

    Medium-term economic health depends on changing the basket of goods produced to better match what is actually needed. If the dislocations and lost income from this transition could be minimized by stimulus, that would be a powerful argument for stimulus: but a stimulus aimed at filling the “demand gap” will simply slow the adjustment, exacerbating the mismatch between capacity and need and increasing the eventual dislocation.

    (Long-term economic health depends on preserving the mechanisms which allow the economy to adapt to changing needs, and government intervention is profoundly deleterious in that respect.)

    Consideration of foreign trade only makes this failing stronger. The less the U.S. economy looks like a closed system, the more the nation’s financial position becomes analogous to that of an individual or family. The “demand gap” prescription is like stating that, regardless of our wealth or ability to pay, we should not reduce our spending. (For “pay” substitute “collect taxes”; for “our” substitute “aggregate”.)

    Suppose that debt-financed private spending and deficit-financed government spending are roughly interchangeable. The market participants have discovered that the former was unsustainable, and now the government is stepping in to effectively overrule them.

    In sum, the idea that stimulus should fill the demand gap is utterly wrong, and leads one to greatly overestimate the optimal amount of deficit spending.

  12. Entrepreneurs will be entrepreneurs, I know, I am one. When I started my business, there was no concern about my tax rate, or stimulus or anything of the sort. It’s either in you, or it isn’t.

    Also understand that you can give all the money in the world to companies to invest and grow, but if no one is buying their products, it will mean nothing.

    So there has to be a balance of being sure companies remain liquid while putting confidence back in the consumer.

    That’s our problem right now. It’s not banking or housing or employment, it’s confidence. Ask Ben Stein, he said it on Sunday Morning. The Velocity or “V” of money has slowed because people are afraid. And their afraid because every time they turn on a tv, radio, or pick up a newspaper it’s nothing but doom and gloom.

    That’s why I started a year ago because I saw this coming. No, I’m not clairvoyant, but as a student of marketing and PR, I know exactly how consumers think and react.

    Every economy in every nation takes a breather… Remember 92% of Americans have jobs, 93% of mortgages are being paid on time, no one is bombing our cities, and we need to keep these things in mind, react cautiously but know we’ll be back…

  13. Great post. I agree with what you have to say, but I wonder about one potential response.

    You say:
    “The fiscal stimulus program is designed to stimulate where economic activity has deteriorated and there are job losses. Many of these areas are those that had over-expanded. As we have been saying for some time on the blog, the effect of this kind of stimulation is to slow down the re-allocation of resources. It will not succeed, however, in preventing it. What it will do is prolong the recession. ”

    Yet, if the stimulus is designed to slow down the reallocation, e.g. prop up dying industries for some time with borrowed money, is it not possible that although it will prolong the recession, it may make it more shallow? It could “save jobs” in the short run, even as it prolongs the necessary restructuring. It could “save” companies that are on the sidelines of the collapse from being taken down, by zombifying dying firms for a while, allowing the sideline firms to reallocate their own resources, find new products and customers, etc, before going under, instead of going under.

    Now, you address some of this by talking about uncertainty of government action on business climate, and lack of knowledge in government investment, allocation and intervention. Yet those problems of central planning also exist in the monetary arena, where it seems you think the government has a role.

    My answer to the reply I posited would have to hinge on the idea that a short and fast restructuring is superior to a long and shallow one, and that in fact it would not end up more shallow due to incentives that subsidizing business causes, the lack of information about where the central funds should go, and the politicization inherent in any government allocation program.

  14. I’m repeating here a comment I left at Cafe Hayek:

    Here’s a fact I never hear discussed by the Keynesians.

    Prior to Hoover’s and Roosevelt’s economic interventions beginning in 1929, the government’s policy during all prior recessions, depressions and “panics” (and there were a number) was pretty much laissez-faire — not completely and purely, to be sure, but in general, the federal government prior to 1929 made little effort to “stimulate” economic activity, little effort to “bail-out” banks or other private institutions and little effort to “save jobs”, keep wages up, etc.

    Yet every one of those pre-1929 recessions, depressions and panics was resolved by the (mostly) free market that existed at that time — and usually resolved within a year or two. Certainly none of them (AFAIK) turned into a depression that featured double digit unemployment for over a decade. And none of them turned into years of “stagflation” or a “lost decade” like the Japanese have experienced.

    If Keynes was right, and capitalism is not capable of curing high unemployment on its own, how is it possible that those recessions, depressions and panics were resolved without massive Keynesian interventions? I think the question answers itself.

  15. Sure, people all over the world can afford to go hungry and starve on their beds (if they have any at all in the first place) while waiting for the miraculous resource re-allocation to happen via frozen up market mechanisms, that in the first place was dominated by finance players/institutions/hedge funds egged on and supported by the likes of economists/people supporting this blog post.

    And oh, when you guys blame the big stomping elephantine government (USA), I wonder if it wasn’t any coincidence that the global economic crisis was birthed during the dying term of a Republican government…IIRC, Republicans like to think themselves as advocates of small governments…hmmmmmmmmm

  16. At least the old Y=C+I+G+(X-M) equation wasn’t a completely aggregated view of the economy. Now its just ‘spending’ that the stimulus fans want more of. Aggregation gone mad.

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