Fairy gold and economic stimulus

Poul Anderson wrote a short story 26 years ago entitled “Fairy Gold” which illustrated how economic stimulus is supposed to work better than anything else I know of.

Poul Anderson

The situation was that a brave but penniless young man wanted to join a voyage of merchant adventurers, but lacked the money to buy a share of the expedition.  His sweetheart wanted him to stay home and work in the pottery shop which she inherited from her grandfather.  Unexpectedly, a bunch of elves maneuvered him into fighting an ogre and at sundown, as a reward for his victory, gave him a a five-pound gold coin, with the warning to spend it quickly.

The young man exchanged the enormous coin for regular money with a banker, and bought himself a share of the ship’s expedition.  The banker exchanged the gold for diamonds at a profit; the jeweler bought pearls from the ship’s captain.  The captain gave the gold to a beautiful aging courtesan, whom he loved, and she bought the shop from the young man’s sweetheart in order to have an income when her beauty faded.  Without responsibility for the shop, the young woman saw no impediment to joining the young man on the expedition.  She rushed to join him, just as the sun came up and the gold coin evaporated, because it was fairy gold.  But although it wasn’t real, everyone concerned was better off for having had it.

Last week the Federal Reserve Board conjured up $600 billion out of nothing, which it will use to buy government bonds.  The board hopes the $600 billion will go sloshing through the economy, and create effects similar to the fairy gold in Poul Anderson’s story.

Maybe it will.  It certainly is not going to evaporate at sunrise.  But it may not go circulating through the economy, either, as might have been the case in earlier recessions.  All classes of people and institutions are in debt – individuals, businesses, local governments, banks.  The prudent thing for them to do if a little extra money comes into their hands is to put it away.  Or invest it in a foreign country, where interest rates, unlike in the United States, are higher than near-zero.

Financial legerdemain got us into the mess we’re in.  I don’t think we can count on financial legerdemain to get us out.

Now Paul Krugman thinks differently. He won the Nobel Memorial Prize for Economics, he has been right about the economy when other economists have been wrong, and he sure knows a lot more about economics than I ever will.  So I hesitate to say he’s wrong.  But where’s the evidence that financial and monetary stimulus is helping?  And how long can we continue in this unnatural condition of near-zero interest rates?

As the risk of beating a dead horse to death, as we used to say in Maryland, I say the best form of economic stimulus is to put people to work doing things that would have to be done anyway, recession or no recession.  Paying workers to replace wornout water and sewer mains or repairing unsafe bridges is a more direct way of getting money in circulation than anything Fed Reserve chairman Ben Bernanke can do.  If this does not help to jump-start economic recovery, we at least have a tangible benefit – non-leaking water and sewer mains and non-collapsing bridges.

The Obama administration’s successful rescue of the U.S. auto industry is a contrast to the lack of results so far from the Treasury’s and the Federal Reserve’s financial hocus-pocus.  We are keeping Americans at work producing actual things with an actual use, not starting some complex process than may or may not have some eventual effect.

The auto industry rescue is unpopular among many of my acquaintances, for reasons I can’t fathom.  The idea is that GM and Chrysler ought to be punished for failure.  But corporations are not people; they are magic entities that we pretend are people.  The GM and Chrysler managers who made the bad decisions have been replaced, the stockholders have taken a hit and many of the workers – who presumably were doing just as good a job as Ford workers – were laid off.  But the end result is that President Obama’s policies have preserved an important national asset.  He deserves credit for having seen it through.

But given the dysfunctional nature of the legislative process, given the resistance he has encountered for the infrastructure work that is already being done, given that all these things must be paid for with actual money = given all these things, I can see why he might prefer to rely on fairy gold.

Click on The Fed’s $600 Billion Statement, Translated into Plain English for NPR Planet Money’s amusing and pointed interpretation of the Federal Reserve’s official statement.

Click on What the Fed did and why: supporting the recovery and sustaining price stability for Fed chair Ben Bernanke’s explanation of the Federal Reserve Board’s action. [Added 11/9/10]

Click on The Fed: Doing It Again for Paul Krugman’s view.  He said the only thing wrong with the Federal Reserve’s action was that it was too timid and too little.  [This is a better Krugman link than the one in my original post.]

Click on Government Motors no more for The Economist’s report on the auto industry rescue.

Click on The Bailout That Worked for The New Republic’s report on the auto industry rescue.

Click on Fairy Gold to read the text of Poul Anderson’s original story along with others in a collection entitled The Unicorn Trade.

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