The recession that began in 2008 has ended. Third quarter Gross Domestic Product rose at an annual rate of 3.5%. While there is little reason to doubt that recovery is under way, doubt remains regarding the causes of this recovery. Many reporters now claim that the results of third quarter GDP derive from the Recovery and Reinvestment Act of 2008.

Some reporters specifically cite the “cash for clunkers” program as the source of this recent improvement in economic conditions. The source of this claim is a recently released study by the Bureau of Economic Analysis. Motor vehicle sales added 1.66% to third quarter growth after adding .19% to second quarter growth. It would then seem that the cash for clunkers program has worked as intended. We must, however, consider what this recent surge in auto sales implies for general economic conditions.

The most reported facts on general economic conditions are the unemployment rate and GDP growth. While these two statistics are important, we must look at additional statistics if we are to understand why unemployment and GDP change. Decreased consumer spending caused an increase in inventories last year. The following chart shows the severity of this increase in inventories.

Total Business Inventory to Sales Ratio

Lower spending and rising inventories force employers to lay off workers and lower reported GDP. Yet the increase in inventories peaked early this year. Industry dealt with rising inventories by cutting production, and this strategy has worked. By last April Chrysler, Ford, and Honda had less than 100 days of inventory. Inventories fell outside of the auto industry as well. For example, inventories of aluminum at Alcoa fell 15% last spring. Falling inventories meant fewer layoffs and cuts in production for third quarter GDP. In fact, second quarter GDP fell by only .7%. The Bureau of Economic Analysis estimates that third quarter GDP would have grown by more than 2% even without any fiscal stimulus.

What is important though is the effect on real employment and production, not just GDP. Were it not for declining inventories last Spring the summertime surge in auto sales would have merely reduced that excess inventory at a later date. So, even if we accept the rationale behind fiscal stimulus, the success of this program must be discounted according to the importance of other factors in the economy that created the conditions under which this policy worked.

First we can consider the role of private enterprise. Inventory management by private enterprise is part of what makes recessions happen, but such management also makes recessions temporary. Gluts in inventories can be cleared only through some combination of price reductions and production slowdowns, and the private sector has worked effectively in this regard. Treasury Secretary Geithner claims that private banks have restructured faster than the private sector. Financial restructuring and further development of the banking system is vital to every industry, but the efficiency of financial institutions is obviously important to the auto industry, as car sales are frequently financed by consumer loan payments. The banking-credit issue is not, however, a purely private affair. The Federal Reserve Bank enacted its own stimulus program approximately one year ago. The Fed drove short term interest rates down as far as it could.

The Federal Reserve also swelled bank reserves at the end of last year.

Monetary and Fiscal policy work gradually, with lags of at least 6 months and perhaps as long as two years. As it turns out, the recession appeared to be ending six months after the Fed enacted its monetary stimulus, and it ended nine months after the implementation of this policy. These facts are hardly coincidental. As previously noted, the private sector contributed to recovery with its own internal adjustment, so we may question the wisdom of the Fed Chairman’s decision to flood the banking system with new reserves. The primary danger now is that the Fed’s aggressive monetary policy could lead to an inflationary boom. But these facts raise even greater problems with the Recovery and Reinvestment Act. There were signs that the recession would end soon prior to the passage and signing of this act by the Congress and the President. Furthermore, aggressive intervention by the Federal Reserve indicated that any alleged need for stimulus had already been realized.

The Bureau of Economic Analysis reports that most of the components of the recent fiscal stimulus were ineffective, except for the incentives to buy cars and houses. We must, however, ascertain the marginal effect of these programs on sales and inventories before we conclude that they have worked. The fact that inventories fell earlier this year does not support the rationale behind fiscal stimulus. Increased production and employment will follow expectations that business sales will remain high. Many analysts expect that GDP will grow at a slower pace in the next few quarters. Third quarter GDP registered a sharp increase because of a onetime boost in home and car sales.

Some of the people who bought cars and homes last quarter would have bought them at this time or shortly after anyway. The cash for clunkers program clearly accelerated car sales for the last quarter, but there is little reason to believe that it will raise sales for the rest of this year. According to an estimate by Edmunds cash-for-clunkers generated only 125,000 of the 690,000 sales during this program. The remaining half million sales would have happened anyway. Car sales for the present and the next quarters will likely diminish.

Of course, the money earned from sales on new cars represents an increase in sales in one industry - but only for one quarter. Consumers who bought cars last summer will not only refrain from buying additional cars this quarter, many of them have likely cut back on other expenditures last summer as they raised down-payments for cars. What this all means is that the net effect of auto sales on GDP last quarter is overstated. To put it simply, The Recovery part of the Recovery and Reinvestment Act was unnecessary, as the private sector moved quickly to deal with the imbalances that caused last years’ recession. The fiscal stimulus has not delivered its intended effect, and this is probably a good thing. Since the Federal Reserve provided excessive liquidity to the banking system we do need to worry about future inflation. We have not realized our potential for inflation because the Fed has been paying banks to hold higher excess reserves in the past year. But we are now in a difficult position where the potential for increased bank lending could cause inflation. To the extent that cash-for-clunkers stimulated consumer credit and bank lending, this program is inflationary. Lets hope that its marginal effect was actually quite small.

Of course, Obama’s plan is also intended to provide for stronger economic growth in the twenty first century. The Reinvestment part of Obama’s program provides substantial funding for highway and railway projects, education subsidies, health care funding for research and preventative care, and investment in cleaner and allegedly more efficient energy sources. On the surface it might seem like a good idea to invest in the aforementioned areas of the economy. But the track record of public investment by the Federal Government is not very good. For example, President Obama wants to increase funding for Amtrak, but it has run losses ever since it began its operations in 1971. Amtrak has maintained its link between Orlando and Los Angeles despite the fact that it lost $433 per passenger in 2004 and $524 per passenger in 2005. To make matters worse, the official estimates of Amtrak losses may be understated by two thirds . There are many other examples of wasteful government spending. Past increases public spending on education have not led to improved student performance. The Cash for Clunkers program is itself a good example of governmental waste. This program provided a one quarter boost to GDP statistics without doing much to stimulate real recovery, and at a very high monetary cost. The per-car cost of cash-for-clunkers appears to be over $20,000. These estimates of the per-car cost focus on the effect that cash-for-clunkers had on sales. The full cost of this program would have to include the cost of old cars destroyed in this program, many of which were still useful. The idea that we can generate prosperity by destroying wealth was debunked by Frederic Bastiat well over a century ago. The destruction of real wealth might stimulate production to replace lost items, but at the expense of producing new net wealth.

Declining Federal revenues imply that additional public spending on programs like cash-for-clunkers translates into more public debt, and Cash for Clunkers has added this years total fiscal burden. The deficit will likely be 1.4 trillion dollars this year, and the national debt will soon exceed 12 trillion. According to some estimates, Obama’s projected spending will cause the accumulation of 9 trillion dollars of debt during his term in office.

The Recovery and Reinvestment Act is diverting large amounts of money into public purposes that serve neither the short term goal of reducing unemployment through so-called economic stimulus, nor the long term goal of raising per capital income through economic development. American taxpayers do not need the additional fiscal burden imposed by the Recovery and Reinvestment Act. American consumers do not need wasteful government spending that diverts resources from the production of useful goods and services. Who does need the Recovery and Reinvestment Act? President Obama. His increases in Federal spending make more people dependent upon his reelection. Companies that receive contracts from Recovery and Reinvestment funding will have reason to contribute to the campaign to reelect President Obama. Workers who earn incomes from Recovery and Reinvestment funds have an incentive to vote for and support Obama. These people will become financially dependent upon his program after it has been fully implemented.

Of course, the people who are slated to receive Recovery and Reinvestment funds are also taxpayers and consumers. The cost of higher taxes are more obvious than the cost of lost economic growth to the general consuming public. But both of these types of costs are real and well worth avoiding. It is too late to stop the so-called stimulus component of the Recovery and Reinvestment Act. It might make political sense for Obama to go forward with his reinvestment plans. This plan does not make economic sense, and it should be abandoned.

D.W. MacKenzie teaches economics at the U.S. Coast Guard Academy. The views expressed in this paper do not represent the official views of the Coast Guard Academy.