Why economic stimulus doesn't equal growth

Whenever you hear the term "economic stimulus," you should question the conventional view that such policies can reverse economic recessions.

An economic stimulus package -- any economic stimulus package -- that is meant to jolt an economy out of a recession will not live up to its promise.

This appears counterintuitive; it seems logical that when the economy slows, an increase in government spending will end the recession.

Recessions, after all, are a persistent drop in economic activity, and if the private sector is unable to avoid a slump, then the government should take its place and prime the economic pump. It doesn't matter where the money comes from or where it's directed -- just as long as someone is spending.

But that's not the way market economies work. There may be some short-term gains to a well-designed economic stimulus package, but they are likely to be small.

Business cycles are a natural part of a market economy. They appear to have a life of their own, and indeed may promote long-term economic growth.

When recessions occur, markets reallocate resources to more productive uses and eventually -- often following much pain -- the economy begins to grow again and create net new jobs. It takes time, but this reallocation suggests that recessions actually are a necessary part of a market economy. Without these adjustments, economies would stagnate.

Does this mean that government should do nothing during times of recession, that it can do nothing to improve the lives of its citizens? Of course not.

Government should provide necessary transitional services for displaced workers -- such as unemployment insurance and training -- to ensure that people can weather the rough spots in a cyclical economy and to position them for the future.

However, there is more that the government can do to positively influence the economy. By focusing resources on the economy's core infrastructure or on public goods, government can lay the groundwork for a strong economy that can better weather recessions.

And of those public goods that government can provide, one with the greatest return on investment is education. Research has shown that when it comes to education, the highest returns come from early childhood development programs, especially for children of lower-income families.

If you want to ensure that the workers of tomorrow will be able to thrive in a dynamic market economy, then you have to give them a chance as children.

It is difficult to convince politicians and the public that the best way to battle recessions is to make smart long-term investments in the economy. Harder still is to convince people that the economy will pull out of this recession on its own. And given the size of the U.S. economy and historical experience over the past half century, it will likely return to normal rates of growth within a year.

Business cycles will come and go, and there really is not much government can do about that. Meanwhile, children still need a good education, and at-risk kids especially need a chance.

Investing in children will strengthen the economy through many business cycles and help ensure that everyone has an opportunity for success.

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Arthur J. Rolnick is senior vice president and director of research at the Federal Reserve Bank of Minneapolis.

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