Why Fiscal Stimulus Fails

Over the past several weeks, we’ve once again seen how the Federal Reserve’s stimulus policy has done nothing to help the economy. Fourth quarter growth for 2015 was a disappointing 0.7 percent, and there are no obvious signs of improvement in sight for 2016. Nonetheless, as the U.S. economy continues to smolder, the Fed acts as though pulling levers on interest rates will get us out of this seemingly endless trough.

The key point here is that what needs to be done is not to fiddle with interest rates, but to make major structural reforms in important economic areas, most notably in labor markets. To start with the basic story, there is at best a tenuous connection between the alteration of interest rates and improved productivity in any market in goods and services. Of course, it can be said that the low interest rates will induce people to borrow. But low interest rates reduce incentives for people to lend their money to those potential borrowers. In addition, the low interest rates tend to lead to lower earnings on savings, which means that many people in the economy, especially retirees who depend on the income generated by their basic portfolio, might reduce their consumption today to conserve wealth for consumption tomorrow. These choices between consumption-now and consumption-tomorrow will be made on an individual basis, so it is hard to see any systematic trend toward higher buying today once low interest rates are in place. It goes without saying that retirees and others living on fixed incomes do not have much wealth in reserve to make capital investments. So it looks as though contraction in the supply of available funds should offset the increase in demand.

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