The Vicious Circle Economy

Total debt outstanding in the US, by sector. S...

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This is a wide ranging and excellent blog post, but it covers a lot of topics. One important part of the post is an explanation of why the various “stimulus packages” can’t work. Better yet, it offers an explanation without resorting to obscure economic theories. Let me summarize:

Government transfer payments could stimulate spending, but not when people are deeply in debt – people will use the money to service the debt. The same is true if people’s balance sheet has been damaged, say by falling house prices or a collapsed stock market. People no longer have the assets they once had and must save to restore their earlier position. Any stimulus will stimulate saving, not spending.

This creates a vicious circle since government spending comes at the expense of government debt which raises expectations of future taxes which discourages most kinds of investment. This government debt will also absorb a great deal of the saving the people are trying to do. Rather than invest in the private sector (and creating jobs), we will loan money to the government.

In short, the stimulus activity of the past few years is actually an anti-stimulus approach. We’ve been making the problem worse, not better.

Even worse, think about what it would take for the economy to recover. This will require many households to be comfortable with their debt and confident in their prospects for future real net income, i.e. not be too worried about inflation or taxes. This strikes me as very unlikely in the foreseeable future.

Better mind than mine will confront this problem, but the only solution I see would be for the government to undertake a draconian austerity program and for a lot of time to pass. The time will surely pass, but government austerity seems unlikely without a substantial change in public outlook.

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