For the past several years, American economists and government officials have been justifying the great financial bailout of 2008/09 in terms of its backlash avoidance effect.
Why backlash avoidance? Well, they explain that excessive consumer and corporate debt represented a primary cause of the 2008/09 crash. And they acknowledge that such overleveraging of debt should usually be rectified by shifting funds from consuming goods and services (i.e. current spending) to repaying debt.
But here’s the rub: if we all decide to stop spending at the same time in order to repay debt, the decline in economic activity could actually worsen the slump that was triggered by the excessive debt. Thus, the economy would experience a backlash effect.
The solution? At the very moment when consumers and corporations feel compelled to “do the right thing” and focus on repaying debt, the government should encourage them to do what is customarily the “wrong thing” and consume more products and services instead. Supplemental government spending (i.e. economic stimulus) may be necessary as well.
Several backlash avoidance policies appear to apply to the American economy of 2014 as well. But today, ironically, government officials may find it advisable to sit back and passively allow the free market to heal the economy.
For instance, the sharp contraction of Gross Domestic Product during the recent winter has been attributed in part to an unexpected decline in health care spending. So should the government rush to stimulate more spending on health care services? Well, no, the Affordable Care Act (i.e. Obama Care) is explicitly designed to reduce the bloated cost structure of the American medical system.
In addition, the home construction market continues to lag below normal historical levels, thus weighing down economic growth. So should the government encourage banks to relax their mortgage lending standards to encourage new residential construction? Of course not; sub prime mortgage loans, also known as “toxic debt,” represented a primary cause of the 2008/09 collapse of the global economy.
Furthermore, the economy continues to be plagued by the unusually harmful effects of long term unemployment among mature workers. So should the government develop new programs to explicitly encourage the hiring of mature workers? Regrettably, such programs may discourage the hiring of recent college graduates, who are struggling with unprecedented levels of student loans.
To be sure, government officials are finding it difficult to passively permit health care spending to slump, home construction to lag, and mature workers to remain unemployed when assistance can be justified on economic (and perhaps even moral) grounds. And yet it was also difficult for officials to authorize the bailout of 2008/09, a decision that may have prevented a second Great Depression.
There is a difference, though, between the situation in 2008/09 and the one that exists today. In 2008/09, an activist government was needed to authorize a bailout. Today, though, by simply allowing economic trends to run their course, the government may be able to ensure a beneficial outcome.
Oddly enough, the much derided paralysis of America’s federal government may help it remain passive in the face of public pressure to take action. In other words, the government’s very dysfunctionality may allow the health care, home construction, and mature worker employment sectors to generate the short term pain that is required to ensure long term prosperity.