среда, 11 марта 2009 г.

Stimulus Thought Experiment

Now let us run a thought experiment.

Imagine a closed economy consisting of 5 members – John, Bob, Mark, Anna and Vera.John’s only function is to govern his small community. John’s debt is owned by a banker down the road (mind the Chinese holders of the US debt) Mark is currently unemployed. And only Bob, Anna and Vera are involved in productive activities (no implied sense here) providing for all the needs of the 5 community members. There will be no increase in the number of members in the community and no increase of consumption of the current resources in the foreseeable future (This is the first unrealistic assumption).

But let us forget about it and suppose the total real wealth of the community is equal to $ 500 and it is stable. On top of this wealth, the economy has $ 500 in financial instruments (money) which circulate in the economy to facilitate exchange among members (This already means that there is no current household debt and that the current real wealth arising from the initial resources will not decrease in the future).

And let us also suppose that due to their animal spirits which have failed them, Mark, Bob, Anna and Vera do not utilize an idle resource, say, a mill. Imagine also that this mill represents all the idle resources in our hypothetical economy.

Now, concerned with the falling public confidence about the future economic growth, John searches through his dusty book shelves and finds (surprise) a Keynesian textbook by, say, Paul Samuelson. He gets inspired and decides that he (the government) must do something to help the economy recover. He decides to stimulate the other members by providing them an interest-free loan (This represents the second assumption that in the future John (the government) will not demand more than $ 100 in real wealth at the moment when the stimulus funds become due). And John prints the needed money on his printer.

Now comes the crucial part of the stimulus story. John distributes the money among members of his community (regardless of the proportion to simplify the case), and this magically makes the community suddenly realize the perfect business opportunity, the gold mine presented by the unutilized mill.John appoints Mark to work on the mill.

Now the problem of unemployment is done away with (Forget that Mark may refuse or be unsuited or unable to work on the mill, otherwise crowding out of the private investment will result from the utilization of the mill because John would need to divert another member of the community from productive activities).

Now let us not forget that in our hypothetical economy no inflation results from the injection of the additional paper money into the economy, otherwise the excess amount of money would be offset by the rise of prices of the initial resources and would not be stimulating enough. The utilization of the mill also does not require diversion of any other real wealth from the economy. The mill can start operating from scratch, the grain used in the mill costs zero. Mark’s needs will still be catered for out of the existing real wealth.

How about Mark’s additional needs for at least more food and water to heroically work on the mill? Well, he will eat grain and drink water from a puddle. He will not need any additional entertainment or other goods which the community does not currently produce.

But unfortunately for the community members, we cannot forget that John will have to have real wealth in the amount of $ 100 to offset the $ 100 deficit he runs because he owns $ 100 of real wealth to the banker down the road who may have the court confiscate part of the community’s real wealth if he does not get payment.

Therefore, simple calculations suggest that the utilization of the mill must miraculously produce a stock of new wealth which will be equal to at least $ 110 to ensure economic growth by the time John demands his $ 100 in real wealth back. Thus, Mark should heroically produce an amount of bread which will be valued as $ 110 by the community members and the banker down the road.

The real wealth of the community is increased by $ 10 - can John declare victory over the animal spirits of his community? Yes, if Mark continues operating the mill at no cost and the increase in the real wealth does not change the preferences of the other community members and many of the assumptions mentioned above remain the case.

Now I did not manage to demonstrate you that John’s (the government’s) victory over recession through economic stimulus is impossible. But the assumptions under which it may materialize, seem anything but realistic. Unrivaled in its bizarreness is the assumption that all that the economic agents need to utilize the supposedly perfectly idle economic resources is the government throwing money at them.

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