The U.S. economy needs to break its stimulus habit
By Richard Rumelt, contributor
FORTUNE — In response to the disappointing second quarter performance of the U.S. economy, Ben Bernanke has suggested that the
Fed may have to initiate a third round of “quantitative easing” and told Congress that it should maintain fiscal stimulus
Does the U.S. economy need another round of stimulus? Before one decides on a policy or strategy, it is important to first identify the problem. In searching for a diagnosis of the present economic situation, I am reminded of “west coast turnarounds.”
In the mid-1960s, when I was in college, one of my best friends dropped out. An indifferent student, Paul had a girlfriend and wanted to get on with life, so he went to a school for big-rig truckers. When I saw Paul again after two years, I was shocked. His eyes were sunken and shadowed and his body had gone to fat. Yet he smiled and proudly pointed out an award on his wall announcing that he was the “Driver of the Year.”
“How did you get that?” I asked. Paul dug into his pocket and pulled out a clear envelope holding a number of large black torpedo-shaped pills.
“These are west coast turnarounds,” he explained. “They let you drive from New York to San Francisco, turn around, and come back without stopping.”
I spouted the usual cautions about what he was doing.
Six months later, Paul’s girlfriend called me because she couldn’t wake him up. I arrived at their apartment at the same time as Andy, one of Paul’s truck driver colleagues. Paul sputtered awake when Andy poured water on his face. Then, Andy offered Paul some strong coffee because he “needed a stimulant.”
A chemical stimulant provides a temporary speed up, a boost that must be paid for later. Notwithstanding Paul’s award for “Driver of the Year,” taking stimulants is not a path to long-term productivity. Andy’s diagnosis that Paul needed “a stimulant” was dead wrong. Paul had been living on stimulants for so long that his body could no longer respond to them. Paul needed to recover and get back to normal.
Like its chemical analog, an economic stimulus is a temporary jolt aimed at helping the economy over a rough patch, with the cost of the jolt paid for out of normal-times incomes. Unfortunately, like Paul, the U.S. has been taking economic stimuli every quarter for a decade, pretending that a sequence of temporary jolts is the same thing as economic growth. But true per-capita economic growth is the outcome of productivity-increasing innovation. You cannot engineer true economic growth by fiddling with fiscal or monetary policy or by financing excess consumption with shaky loans.
To recount recent history, the U.S. federal government began stimulating the economy in 2001, at first in response to a recession and then in fear that 9/11 would dampen growth. During 2001-2004, the Bush administration pushed through tax cuts, offered $35 billion in tax rebates, and changed asset depreciation rules to front-load business cash flows, all presented as measures to stimulate the economy.
More important than these fiscal stimuli, the Federal Reserve began to loosen monetary policy, driving down interest rates. The economy climbed out of the 2001 recession later that year, but rates on three-month treasuries were nevertheless driven down from 4% to 3.5% by late 2002, then to 1.6% in late 2003, then to 1% in 2004, rising to a still-low 2% in 2005.
Despite a reasonably healthy economy, the Fed kept stimulating the economy with very low interest rates because there seemed to be no inflation. And there seemed to be no inflation because, down in the boiler room of the Fed, there was no meter labeled “soaring home prices.”
The massive stimulus of very low interest rates from 2003-2005 helped power the housing bubble. When the artificial stimulus of 1% interest rates was removed, home prices slowed their ascent and, as we all know, began to crater in 2007-2008. This bursting of the housing bubble ignited a new round of stimuli. Interest rates were brought to the lowest levels in history — essentially zero — where they reside today.
In 2008-2009, the government provided $65 billion in tax rebates, offering cash for clunkers and tax rebates for first-time homebuyers, spending over $750 billion to stimulate the economy. During 2009-2010, the Fed embarked on a program called “quantitative easing” in which it purchased $1.3 trillion in bank debt, mortgage-backed securities, and Treasury notes with newly created money.
Then in 2010-2011, the Fed embarked on another round of “easing” during which it created an additional $1 trillion in new bank reserves by buying bonds on the open market. The apparent purpose of this last “stimulus” was to artificially inflate stock and asset prices to make people feel richer and more likely to borrow and spend.
A decade of constant stimuli has produced the same effect as Paul’s west-coast turnarounds — a series of highs and crashes followed by a comatose condition that no longer responds to stimuli. Despite what various politicians and experts tell you, real productivity gains and real economic growth do not come from taking stimulants.
Richard Rumelt is the Harry & Elsa Professor at the UCLA Anderson School of Management. He is the author of Good Strategy/Bad Strategy. Visit his blog at www.strategyland.com.