The Failure of Stimulus Spending in a Global Economy

One of the big questions in economics since the great recession began has been whether stimulus spending has been an effective driver of growth for the United States. On one side of the debate you have Keynesian economists. They believe that without the intervention of the government into the economy during the great recession, and the extraordinary monetary easing since, that we would be in a much worse situation than we are now. They point to the continued failure to grow in European markets undergoing austerity budget cuts as proof of concept. Their argument is, when the broader market contracts its spending, it is the government's job to expand spending to keep people employed and return the country to fiscal solvency. On the other side of the argument, economic conservatives and Austrian economists say that government spending comes at the expense of the broader economy and that government economic interventions create economic miss-allocation which lead to future economic contractions (which they view as market corrections). They point to the continued failure of alternative fuels to become economically viable, despite the large amount of government support they receive, as proof that government intervention is a waste of money and a net loss to the economy.

Recently this debate has heated up as the Federal Reserve has begun tapering its quantitative easing program. Quantitative easing is the program by which the Federal Reserve is intervening in capital markets and buying assets to prop up prices and increase liquidity (i.e. the money supply). The belief is that this, coupled with keeping the federal interbank lending rate at near zero, will flood the broader economy with money which will lead to more hiring and more production. The debate has heated up as a result of what is actually occurring as the Fed is reducing its asset buying program. If you believe that quantitative easing supports the domestic economy, then you would imagine that tapering it, reducing these funds, would cause the domestic economy to slow down. What is actually happening though is that it is the developing world that has seen their economies decline as a result of the taper. Here is a good short summary of this by The Economist.

The reason that the developing world is being hit so hard should not be that big a surprise if you think about it. The companies that are best positioned to take advantage of Fed policies are financial companies. They borrow from the Fed, own large quantities of assets to sell it on the open market, they are constantly seeking to leverage their holdings for greater returns, and are always searching for greater yield. Recently, the economies with the highest growth rates and the highest returns on investment have been in the developing world. Since most of these investment companies invest internationally, it makes sense for them to look internationally to make the most money for their investors and stock holders. This is only a problem if you are the government extending them virtually free money in order to boost your domestic economy. The implication here is that in a global economy, traditional liquidity measures and even more radical quantitative easing, are not an effective way to stimulate the domestic economy. This also would go a long way towards explaining why hiring has not picked up, and the economy has grown at record low levels for a recovery, despite record levels of government support.