WHY DO WE NEED GOVERNMENT ECONOMIC STIMULUS?
It seems to be pretty widely agreed that we need some sort of stimulus package from the government. Many say that it should spend a lot of money fast, not worrying about the possibility that it might have a deficit. But there are still some who say the opposite – that government should do as everybody else tends to do when times are bad, and cut spending.
I think we need the stimulus. Normally, governments do not try to do this much any more. It has become accepted that, under normal circumstances, recessions are best dealt with by the central bank, which, in our case, is the Bank of Canada.
But this recession is different, and I doubt if the Bank of Canada can do it alone.
The Bank of Canada controls our money supply. If it thinks the economy is operating below capacity, it creates more money. The amount of money it has is just a number in a computer somewhere, and it effectively just increases that number. Bet you wish you could do that!
After the bank creates that money, it needs to get it out into the real economy. Normally, it does this by buying bonds from financial institutions. That increases the amount of money that those institutions have available to lend, and reduces interest rates.
Lower interest rates encourage investment in houses and businesses. More people get hired. Soon, people are buying as many goods and services as the economy can produce. The Bank of Canada tries not to push it beyond that point, as that would just create inflation. Actually, it uses the inflation rate as a gauge of how close to capacity the economy is.
Stimulating the economy this way has a limitation. No matter how much money the Bank of Canada creates, its interest rate won't go below zero.
If things get really bad, financial institutions won't want more money to lend even if they can get it for next to nothing. They will be too afraid to lend because of the risk their customers will be unable to repay.
Then the central bank could be unable to get the money it creates out into the real economy where it could put real people back to work. This is called a liquidity trap.
This doesn't happen often. The last time it seems to have happened here was the great depression of the 1930's. There is a great deal of evidence that Japan's “lost decade” in the 1990's was also such a phenomenon. And there is much reason to think that the whole world is again entering such a situation.
This is why we need a stimulus package now. Heavy government spending is another way to get enough money into the economy that people will buy as much as the economy can produce and thus keep unemployment from ballooning.
Now is the time for a stimulus package, because the unemployment rate is starting to rise. The Bank of Canada has just about done all it can do, with the interest rate at 1.5%. It's an exceptionally bad time to start playing political games and shut down meaningful action for a couple of months.
Let's hope the federal politicians can get their act together faster than now looks likely. Also, the provinces should be getting into the act. They certainly should not be “tightening their belts” or laying people off now.
All levels of government should be doing all they can to avoid more economic disruption now. Support sectors that are hurting. Avoid lay-offs. Expand support for the unemployed. These are not normal times and normal rules about avoiding deficits do not apply.
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