Friday, February 27, 2009

Stimulus Packages & Efficient Resource Allocation

What has stimulus packages got to do with the efficiency of resource allocation? Everything, but quite on the reverse.

The idea of an efficient resource allocation comes from the idea of the price mechanism to do the allocation and the idea of competition to ensure its efficiency.

If there is a deliberate attempt to stop the price mechanism from working to allocate resources even in the downturn - to allow those with cash to buy cheap assets at firesell prices - then there will be no resource re-allocation. The resources will still be stuck in the hands of those who have made a complete mess of things but those who have been prudent would not have a chance to exercise a market opportunity.

By right, in a down market, there will be more producers and more workers who are out to compete. At the very least, stimulus packages will be open to the general public so that competition will ensure the best value for money for the packages.

This is the ideal, and the reality is harsh. For one thing, stimulus packages are never big enough to save everybody. But at least those with the least muscles will be left to die.

But the real idea of a stimulus package is form a bottom for the economic downturn so that people can see that there is an end to the decline. It will really stimulus only when the economy is well passed the bottom and could possibly be on the upswing. Then, there will be some kind of a stimulus.

The recession is always a good time to tweak the economic system and repair the faults that have shown up. But there is a danger of overdoing the tweak to the extent that it may make it a bit harder for the system to jump-start itself.

The trick is to let the system be easy when times are hard and for the system to be tough when times are too easy.

Policy thinking today is entirely out of kilter. Policy is easy when times are good - in order to ensure that times are good. Policy becomes non existent when times are bad - when everything is loosened until there is no control.

Zero interest rates - what a ridiculous idea!

I think there should be a bit of disciplining of the economy, by ensuring that investments are done with a decent rate of return and that savers are rewarded for saving their money for a rainy day. Without this discipline in the investment market, we will have gross misallocation of resources to the extent that savers are being punished while abusers of resources are being rewarded with bad ideas.

There is no wonder that we end up with a lot of junk we do not need.

Or are we in the midst of a turning point in civilisation where life as we know it in the balancing of work and play is going to be different. Where work has become play and play has become work. And our accounting of economic value-add may be inadequate for policy to adjust accordingly.

Stimulus packages of any kind are at best a stop-gap measure. Resource allocation is not only temporal with respect to price but inter-temporal with respect to the rate of interest.

1 comment:

pywong said...

Hi etheorist, I like your writing.

One question: You say savers are punished for low interest rates. This is only for those who save in paper money. If we invest in precious metals, we are not vulnerable to Central Banker interest rate policies.

py