Why Stimulus Doesn’t Lead To Organic Growth

There is a growing consensus in Washington the only way to fix the worst economic downturn in more than 70 years is by giving out more free money. From Joe Biden to Janet Yellen, to most members of Congress, there is a demand for more “stimulus.”  However, the reason the previous programs failed is the stimulus doesn’t lead to organic growth.

Let me explain.

Joseph Carson, the former Chief Economist at Alliance Bernstein, recently noted:

“Suppose Congress passes something close to Biden’s Administration stimulus proposal of $1.9 trillion. In that case, that will lift the cumulative amount of fiscal stimulus in the past 12 months to $5 trillion—three tranches $2.2 trillion, $900 billion, and $1.9 trillion.

In the past year, nominal GDP totaled $21 trillion, so the cumulative injection of fiscal stimulus amounts to almost 25%.

Nothing in modern times comes close, especially during peace times. CBO published a report in 2010 on the military costs of significant wars. The military war costs of World War 1 amounted to 13.6% of GDP and World War 11 35.8%—-so the current spending/stimulus is in the middle of the two World Wars.”

stimulus organic growth, #MacroView: Why Stimulus Doesn’t Lead To Organic Growth

It is an incredible amount of intervention relative to the underlying crisis. As Joseph pointed out, there is a significant difference between today and WWII.

“During World Wars, activity in the private sector is depressed. That’s not the case today. The housing sector is booming, with housing starts at the highest levels in 15 years, and prices are rising double-digit to record levels. At the same time, the manufacturing sector is experiencing a mini-boom in orders and production.”

However, to understand why more stimulus may not create economic growth, we need to review how we got here.

A Brief History

In March, as the economy shut down due to the pandemic, the Federal Reserve leaped into action to flood the system with liquidity. At the same time, Congress passed a massive $2.2 trillion fiscal stimulus bill that expanded Unemployment Benefits and sent checks directly to households. Then in December, the Trump administration hit the economy with another $900 billion. Now, the Biden administration anticipates repeating that with another $1.9 trillion. As shown below, with money pouring into households’ hands, it is not surprising the economy rebounded.

stimulus organic growth, #MacroView: Why Stimulus Doesn’t Lead To Organic Growth

That surge in the third quarter, and surging stock market to boot, directly responded to both the fiscal and monetary stimulus supplied. The chart below adds the percentage change in Federal expenditures to the chart for comparison.

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