Saturday, February 14, 2009

The most effective forms of stimulus

I posted a chart here a few days ago showing that the most effective forms of stimulus in an economy with deflationary expectations were a) food stamps, and b) infrastructure spending, and the least effective was tax cuts or direct cash to consumers. The question is, why?

The answer is pretty simple: Mattress money. Note that physical mattresses are not required, if you give it to a bank and the bank doesn't lend it out, it's basically mattress money at that point too, it's just the bank stuffing it into a virtual mattress at that point. The deal is that money has value only insofar as it is used to trade for goods and services in an economy. Money has no inherent value other than as oddly shaped pieces of toilet paper. So mattress money is literally toilet paper as far as the economy concerned, doing nothing at all to foster the movement of goods and services in the economy (it is the goods and services in the economy, not money, that has actual value).

So anyhow, if you give money to people when they're facing deflationary expectations (i.e., expectations that their income is going to be less in the future), they're going to stuff it in a mattress. If they give it to a bank and the bank is facing deflationary expectations, then the bank is going to just let it sit on account rather than lend it out, in hopes that when the economy turns around so that people's incomes are rising then they can loan it out with a higher rate of return than if they lend it out while people's incomes are declining. In short, giving money to people is an effective way to stimulate the economy when people have inflationary expectations -- the money will be worth less in the future so might as well spend it now -- but it stimulates very little spending when people have deflationary expectations, they'd rather save it because it'll be worth more to them in the future (when they lose their job or whatever).

So if you're wanting to promote the flow of goods and services in the economy, and thus employ people to provide those goods and services, and your population has deflationary expectations, you cannot simply hand out the money. You have to hand it out with strings attached. And that's what food stamps and infrastructure spending have -- strings out the yin-yang. You guarantee that the money will take at least one turn through the economy buying goods and services. Today's food stamp program uses a credit card thingy and you have to spend the balance in a month. No spend, it goes away. So people will buy food in it, which will employ grocery store clerks and stockers and truckers and food processors and so on and so forth, so it has a very high multiplier effect -- that money touches a *ton* of hands before it finally ends up under someone's mattress.

Infrastructure money has the same kinds of strings attached. If you get money to build a bridge, you can't just stuff the money under your mattress. You damn well have to build that bridge. You have to buy steel, hire riggers, buy concrete, and the steel companies have to buy coal and ore and pay truckers to carry the steel to you, the riggers have inflationary expectations for the duration of the contract to build the bridge (which may be several years) so are more inclined to spend the money rather than stuff it under a mattress and will spend the money in bars near the work site and on Harleys and shit, the concrete company has to hire more workers to make all the concrete needed and hpay truck drivers to haul the concrete to your site, and once again that money touches a *lot* of hands before it ends up under someone's mattress. And each time it touches someone's hands, it's adding value to the economy because that's a transaction that would not have occurred except for the initial infrastructure spending.

So anyhow, that's why food stamps and infrastructure money have a larger effect upon the economy in an era of deflationary expectations than simply giving money away. It's all about mattress money, and keeping that money you're handing out from heading straight to mattresses rather than going towards creating jobs and services in the economy. Thanks for paying attention, class!

-- Badtux the Economics Penguin

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  1. A very easily understood explanation of the stimulus.
    To bad the Rethuglicans aren't smart enough to understand it.


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