The Euphoria Behind Stimulus Plans Is Unwarranted

June 21, 2021 Updated: June 23, 2021


The U.S. retail sales and jobless claims weakness, significantly below estimates, coincides with the largest fiscal and monetary stimulus in history. Something isn’t right when these figures come significantly below estimates in an environment of massive upgrades to gross domestic product (GDP). Why?

The diminishing returns of stimulus plans are evident. Artificially boosting GDP with large government spending and monetized debt generates a short-term sugar high that’s rapidly followed by a sugar low. The alleged positive effects of a $1 trillion stimulus plan fade shortly after three months. I recently had a conversation with former Federal Reserve nominee Judy Shelton, in which she mentioned that the recovery would be stronger without this latest massive stimulus package. The economic debacle happened due to lockdowns, and the recovery comes from the reopening. We need to let the economy breathe and strengthen, not bloat it.

The diminishing returns of stimulus plans are evident. A $20 trillion fiscal and monetary boost is expected to deliver just a $4 trillion real GDP recovery, followed by a rapid return to the historical trend of GDP growth. This will likely lead to new record levels of debt, weaker productivity growth, and slower job recovery. The pace of global recoveries since 1975, according to the Organization for Economic Co-operation and Development, shows a weaker trend.

Deficit spending is mostly devoted to current spending, which leads to an almost negligible potential growth improvement. If any, evidence suggests fiscal multipliers are poor, even negative, in highly indebted and open economies.

We must be cautious of the excess of euphoria that emerges from many statements about the so-called European “Next Generation” funds. Many of the optimistic estimates seem to forget the negligible effect of previous similar plans.

The sharp increase in contributions to the European Union budget and the tax increases announced by some countries such as Spain will likely diminish the net effect of these funds.

All the success or failure of the European recovery plan rests on the estimates of the multiplier effect of the investments made. And the prospects aren’t good, if we look at history.

The average impact of the previous programs, such as the 2009 Employment and Growth Plan, the Juncker Plan, or the Green Directives to support investment in renewables, has been extremely low. The empirical evidence from the last 15 years shows a fiscal multiplier range that, when positive, moves between 0.5 and 1 at most. And in most peripheral countries, the values have been negative.

According to the European Union’s own estimates, the Juncker Plan generated between 2014 and 2019 a total impact of a 0.9 percent increase in GDP and added 1.1 million jobs from 439 billion euros invested. The return on invested capital of this massive plan was beyond poor. And let’s remember that the Juncker Plan was used entirely for investment projects with expected real economic return and without the amount of current spending and political intervention of the 2021 recovery plan.

Can we really believe in an impact of 4 percent on GDP in three years from these European funds as the average consensus estimates when the Juncker Plan generated—if we believe it—0.9 percent in five years?

The government of Spain, in its Recovery, Transformation, and Resilience Plan, states that “in aggregate terms, the employment generated by the Plan … would be equivalent to about 12 jobs for every million euros invested.” Twelve jobs per million spent!

The multiplier effect and its structural impact depend on execution and efficiency factors that are more than questionable. The likelihood that these funds will be malinvested or squandered is enormous.

The idea that hundreds of magnificent and profitable projects will suddenly appear is also questionable. It’s very difficult to believe that, suddenly, thousands of profitable and job-creating projects will appear when they weren’t carried out in recent years with interest rates at historic lows, unlimited liquidity, and a growing investment appetite.

These so-called stimulus plans have a huge risk: They involve a huge transfer of wealth from the middle classes and taxpayers, which is destined for political spending without real economic return and investments of doubtful profitability.

There has never been capital available for technology, digitization, and sustainability investment. These investments don’t need political direction or funding.

Cheap money, increased public intervention, and massive stimulus plans haven’t worked as drivers of productivity and potential growth. The path to stagnation and zombification was already a problem in 2018. We need private investment and free trade to boost productivity. We need open economies with a thriving entrepreneurial spirit, not an economy based on spending and debt.

The problems created by the chain of stimulus of the past years are clear: elevated debt and weak growth. More spending and debt won’t solve them.

Daniel Lacalle, Ph.D., is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Daniel Lacalle
Daniel Lacalle
Daniel Lacalle, Ph.D., is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”