The Consumption Fallacy – Good Money After Bad

The logic behind the bailouts and government stimulus to consumer spending is that such measures will kick start the economy and prevent a deep recession or a recession even occurring at all. This is accepted in many quarters as a sound economic policy. However, when one looks at it closely it doesn't really stand up to scrutiny. If high levels of consumer spending create economic growth then why does the economy fall into recession in the first place? There is no argument that up until 2005/6 the consumers of the Western world were in overdrive not requiring any government encouragement for their activities. The answer that is put forward is that suddenly the consumer loses confidence and this negative psychology, despite what the government's claims are 'sound fundamentals', is what drives the economy into recession.

This leads us to the obvious question why if the fundamentals are sound would the consumer suddenly become negative? In addition to sound fundamentals the government takes every step it can to prevent negative economic news coming into existence. Inflation definitions are changed and various statistical techniques are used to keep the GDP figures above 0. It doesn't seem to matter how many jobs the US economy has lost in the last 18 months as the GDP has mainly been in positive territory. The consumer becomes negative because despite all the spending, and positive economic news, negative economic conditions start to appear. This leads us to the further question why if consumers spending at full tilt does not prevent the economy from falling into recession will stimulus to consumer spending cure the recession? We already know that high levels of consumer spending do not prevent economic downturns.

Is there something all of this beyond market psychology and multiplier effects? Clearly the answer is yes. There is a simple logical economic reality to it all. If over time more economic goods are consumed than are produced, or saved correctly (in areas that will produce goods that will be demanded by consumers at some point in the future) as investments to produce future goods, then wealth decreases. More government attempts to stimulate consumption will actually destroy wealth in the medium term making the current situation even worse and it longer for the business cycle to come back around to where savings and consumption are in the right proportion to produce wealth.