Friday, January 23, 2009

Stimulus injects no aggregate demand till private investment flows

Bruce Bartlett has an excellent article in the Forbes which needs greater attention but the folly is many of the professors of economics don’t understand it is certainly true in India as well.

 “…view among economists was that government had nothing to do with business cycles--it neither caused them nor was there anything it could do about them. They were like the weather; you just coped the best you could.

Government isn't always responsible--bubbles can occur on their own, as they have over the centuries--but systemic errors usually result from government policy. 

The Federal Reserve, our nation's central bank, is the institution mainly responsible for altering the terms of trade. That is because it has the power to change the value of the currency, which is the intermediary in every single economic transaction, and also to alter the terms of every intertemporal transaction--those between the present and future, such as saving today to consume tomorrow--by raising or lowering the interest rate.

No one today believes that the Great Depression just happened or dragged on as long as it did because the private sector kept making mistake after mistake after mistake. It only made them and continued to do so because government interfered with the normal operations of the market and prevented readjustment from taking place.

The Great Depression resulted from a confluence of governmental errors. 

Unfortunately, Franklin D. Roosevelt misunderstood the nature of the economy's problem and tried to fix prices to keep them from falling--thus preventing the very readjustment that would have brought about recovery

As economist Hal Varian of the University of California at Berkeley recently put it, "Private investment is what makes possible future increases in production and consumption. Investment tax credits or other subsidies for private sector investment are not as politically appealing as tax cuts for consumers or increases in government expenditure. But if private investment doesn't increase, where will the extra consumption come from in the future?"

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