As George Mason University economist Russ Roberts says, government’s stimulus of an economy is equivalent to taking water from the deep end of a pool and pouring it into the shallow end. Thus, all talk of stimulus is nonsense. Both Democrats and Republicans have bought into this Keynesian nonsense, even if they wish to implement it in somewhat different ways...
So, then, how does an economy recover? It doesn’t recover through central-bank policies aimed at keeping interest rates low, discouraging saving, or fiscal policies aimed at boosting consumption, including the government’s own consumption of resources. It doesn’t recover through reinflation of burst bubbles. Recessions (low to negative growth, unemployment, idle resources) follow booms and bubbles, which are caused by central-banking polices that fill the economy with cheap credit and regulatory programs that channel the credit into particular areas, such as the constellation of easy home-purchase policies carried out by several government agencies for years. The booms set off by those policies are characterized by a misshapen capital structure; that is, resources and labor were arranged according to price signals distorted by the central bank and other government agencies. For example, labor and equipment went into the housing and housing-finance industries to a vaster extent than they would have gone absent those price-distorting policies.
When interest rates finally rise to reflect reality, the boom ends, revealing the unsustainable nature of the misshapen capital structure. Businesses close, workers are laid off, and capital is left idle. The effect ripples beyond the immediately affected industries. If government were to retrench at that point, entrepreneurs would set out on the task of re-arranging resources and labor in order to align them with entrepreneurial estimates of future consumer preferences.
This rearrangement is neither costless nor instantaneous. Equipment made for one purpose may be unsuitable for other purposes and may have only scrap value, or it may be in the wrong location. Likewise, people trained to build houses or to work with financial computer models may not be qualified for other jobs and will need retraining. The work of changing the structure of production from its politically distorted shape to one that will better serve consumers requires money. There’s only one place that money can come from if the economy is not to be further distorted: savings. But saving is consumption deferred. Thus all government efforts to stimulate spending and discourage saving accomplish the opposite of what is required for economic recovery.
Free people create economic growth when government backs off — slashes spending and taxes, ends regulations and privileges — and lets them correct the mistakes induced by earlier monetary and regulatory stimuli. Nothing less will work lastingly.