Today brings news that the British economy only grew by 0.2 percent in the second quarter of 2011. Predictably enough, this has led to renewed calls for a ‘Plan B’ for the economy. Typically, that means more borrowing, spending, and money printing. That’s fiscal and monetary stimulus, to give it its technical name.
Well, I don’t want a Plan B. In fact, I don’t really want a ‘plan’ at all. As I see it, the advocates of stimulus completely misunderstand how the economy actually works. They imagine a motor that’s stalled and needs to be jumpstarted. Just give us a quick boost, they say, and we’ll be up and running like we were before. But in reality the economy is vastly more complex than that crude model can appreciate. It’s not a motor; it’s the product of billions of individual choices and actions. And you can’t ‘fix it’ like a broken down car.
During a boom, the economy gets distorted. With too much easy credit and too much money sloshing around, people make bad investments and take on too much debt. You get bubbles forming in particular sectors of the economy and capital being misallocated as a result. When the bust comes, these bad decisions have to be undone, and new plans have to be made. That’s what a recession is all about: liquidating unprofitable investments, paying down debts, reallocating your scarce economic resources to reflect changed consumer preferences. It’s about adjustment and recalculation, and that means it is a process that takes time.
Attempts to stimulate the economy prevent that adjustment from taking place. They might dull the short-term pain, but they also make a return to sustainable growth very difficult. Look at Japan – they’ve have years of near zero interest rates, several bouts of quantitative easing, and repeated fiscal stimulus. They’ve built the bridges and the roads that Keynesians are so keen on, and they’ve kept their zombie banks on life support. The result? Two decades of stagnation. You have to let the economy adjust: plain and simple.
So what should the government do? In the short run, it’s pretty straightforward: they need to bring spending and debt under control, maintain a stable monetary environment, and make sure that failed businesses (like banks) can be resolved without it triggering mass panic. Then they just need to let things work themselves out. In the longer run, there are things you can do to boost growth: cutting red tape, eliminating barriers to entrepreneurship, cutting taxes on saving and investment. But here and now, we need to be patient: real growth will return, if we let it.