State stimulus feeds an unhealthy habit

It has become widely accepted that America is in a better position to counter recessionary tendencies than Britain. America’s stronger public finances give it more leeway, so the argument goes, to bolster the economy with a fiscal stimulus.

It may be true that America’s finances are healthier than Britain but even on the other side of the Atlantic there are problems.

America has become so dependent on stimulus packages of various sorts that their effect could start to diminish. Like a drug addict it needs ever larger doses to keep it going.

The roots of America’s recent turmoil lie partly in the low interest rates earlier in this decade. For more than a year interest rates stood at 1.0% as the authorities tried to deal with the fallout of the bursting of the technology bubble.

This loose monetary policy in turn created the conditions for the housing bubble that has burst more recently. If interest rates are again kept low for a protracted period there could be similar destabilising consequences.

An alternative could be that banks are reluctant to lend despite low official rates. Since so many financial institutions have suffered as a result of the credit crunch they are likely to tighten their lending criteria. If this happens then rate cuts are unlikely to have the desired effect even in the short term.

Nor is fiscal stimulus without its problems. It could be that Americans decide to save the proceeds of their tax cuts rather than spend them. In that case the stimulus could fail to take effect. But even if they do spend their actions may not bolster the economy in the way the authorities desire.

At best the combination of fiscal and monetary stimulus is likely to provide short term relief to the American economy. It might ease the problems in the short term but they are only likely to reappear in a new guise.

More fundamentally the extensive dependence on state-backed action calls into question America’s self-image as a free market. The economy can hardly be described as getting by with minimal state intervention. It may not have vast swathes of nationalised industry but the state is widely involved in bolstering the economy.

Such intervention is arguably necessary in some circumstances. But the trend is for America to become ever more dependent on state support.