The Wrong Weapon for the Wrong War

The emergency fiscal and monetary policies recently announced remind me of the saying: Generals always fight the last war and economists always fight the last recession. The Great Recession of 2007-2009 was a demand shock recession. The banking system collapsed which required large purchases of bonds by the Federal Reserve and fiscal stimulus to prop up aggregate demand and employment.

But the Covid-19 recession is of an entirely different nature. It is a supply shock recession which was caused by a disruption in the productive capacity of the US and our trading partners, especially China. Although temporary, this supply shock will likely last for several months.

Flooding the markets with cash will prevent the banks from insolvency and it might allow stock market speculators to cover their margin calls, but that won’t stock grocery store shelves or fill our ports with loaded ships.

With so much new money chasing fewer goods I would expect inflation to finally return from its long slumber. Fighting the oil supply shock of 1973-74 with expansionary monetary and fiscal policy was a major cause of inflation in the 1970’s. Once started, inflation is a difficult malady to eradicate in an economy.

A better policy would be to attempt to ameliorate the temporary disruption to our supply chain with rationing of essential goods. I know that solution sounds bad (because it is) but its better than doing nothing and even better than throwing money at a drop in real output.

Published by TheLoneEconomist

I am a PhD economist who studies just about anything and proudly specializes in nothing.

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