The visible hand in economics

When not to stimulate

Posted on: November 18, 2008

Sorry for linking to the Standard twice in one day, however they have written about a couple of things I wish to touch on recently. In a recent post Irish Bill states that:

One of the things I like about being left wing is how often the best moral decision is also the best economic decision.

Take economic stimulus for example.

Now, on the first point I would state that the best policy decision and the “morally right” decision always match when you are a utilitarian like me. Getting the two to separate in anyway involves making some pretty specific assumptions and what a “economic decision” is and what a “moral decision” is.

Still this isn’t the point I was interested in discussing – I was interested in Irish Bill’s belief that a stimulus package is good policy in the New Zealand environment. In a credit driven slowdown like the one we are facing a stimulus is not the way to fix things as we are not suffering from a “demand deficiency” – or at least not the type that cannot be solved with monetary policy.

Fundamentally beyond the reduction in income our nation will face as a result of the slowing world economy (a factor that the government can do nothing about) there is a credit channel impact where people are unable to access credit. In the face of this credit constraint a less credit constrained government may be able to borrow funds and share them out to consumers – thereby reducing the impact of the economic crisis. If we believe that New Zealander’s will temporarily suffer from credit constraints, and we believe that the government can appropriately target any stimulus then this could be a good idea.  In fact, this is the primary reason why the Reserve Bank is so determined to get interest rates down at the moment.

But is that what is really going on? In countries that have been lending to us income growth has cooled sharply. If they expect this dip in income growth to only be temporary they will now wish to lend out less – a factor that will push up the fundamental level of interest rates.

If global interest rates now need to be higher they need to be higher – there is no way we can “stimulate” our way out of that. Trying to push consumers to spend more now would merely means that they will have more debt to pay back later, and at higher interest rates.

I just can’t buy the argument that New Zealand is suffering from a “demand deficiency” problem at the moment – merely 18 months after we were complaining that savings rates needed to increase. If we believe that there is a demand deficiency we must also think that the savings rate is too high – no using the paradox of thrift until we see a large run up in under-utilised resources! Without a “demand deficiency” stimulation is inefficient, it is wasteful, and it will just make matters worse.

3 Responses to "When not to stimulate"

[…] Fundamentally beyond the reduction in income our nation will face as a result of the slowing world economy (a factor that the government can do nothing about) there is a credit channel impact where people are unable to access credit. … Read more here […]

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[…] Fundamentally, for New Zealand, there appears to be no reason for any change to fiscal policy to help deal with the slowdown – something we have discussed here. […]

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