By EUGENE F. FAMA
There has been lots of response to my little essay on bailouts and stimulus plans. I will only comment on the negative ones that I think have merit and are overlooked in my original paper.
First, however, I want to restate my argument in simple terms.
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
Are any of these statements incorrect?
The size of the stimulus plan increases every day, currently to more than $800 billion (which president-elect Obama calls a down payment). Finding productive uses becomes an ever more daunting challenge.
To date there is just one valid negative comment on my essay, from J. Bradford DeLong (Fama's Fallacy, Take I: Eugene Fama Rederives the "Treasury View"), and I think his point is actually consistent with my argument.
He accuses me of not understanding that private investment includes inventory investment, and some inventory investment may be involuntary, the result of a general decline in demand. I am aware of the point, and I think he is right that government expenditures can, in whole or in part, reverse this bad investment by giving people funds to buy up the unwanted inventories. I think possibilities like this are covered by a statement that appears a couple of times in my essay,
"And bailouts and stimulus plans only enhance future incomes when the activities they favor are more productive than the activities they displace."
Inventory investments that turn bad are just an example of an unproductive private use of resources, and perhaps I should have used this example in my essay. I just didn't think it's a big enough deal. The relevant numbers are provided by the Department of Commerce.
Inventories rise during 2008, but if I'm reading the numbers correctly, the total increase from November 2007 to November 2008 is only about $47 billion. There is, of course, no guarantee that all of this is a bad investment. Even if it is, and even in the unlikely case that a dollar of stimulus reduces unwanted inventories by a dollar, we would have to find $753 billion of other unproductive private activities to justify an $800 billion stimulus.
Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.