Economic question - money and debt

[mr friendly guy]

Ok consider the following situation.

A man has $1 million in a bank account with zero interest and does nothing with it. Now this man decides to withdraw all the $1 million dollars and gives it to a beggar, just because.

Assuming the beggar doesn't lose the cash or burn it or keeps it under the bed, I have presumably stimulated the economy by at least $1 million. That is the beggar spends all of it and we assume the people who got the money from his purchases, spend some of it and the next batch of people spend some of it and so on, ie the multiplier effect.

Now consider the following two situation.

A man borrows $1 million dollars from a bank under false pretences. Instead of buying a house as he claimed he gave the money to a beggar who spends it etc. Now the question is it stimulatory to the economy or contractionary given

a. The bank manages to recoup the $ 1 million dollars by selling the assets of the man who borrowed the money
b. The bank fails to recoup the $1 million (say all assets of the man who borrowed the money got burnt down in a mysterious fire).

Intuitively I think the first situation would still be stimulatory because of how the beggar spends money. The lost of the money to the bank is recouped from the sell of an asset which isn't "doing anything" economically with it. I also feel that the second would be stimulatory assuming the bank can take the $1 million dollar lost without affecting its other services. However I am unsure.

Thoughts?

[Borgholio]

Both ways stimulate the economy but the second way actually does a better job of it. The first way, the money is spent on food, shelter, clothing, etc...and directly benefits those businesses who provide the products. The second way does the exact same thing except the man's property is seized by the bank and sold after the fact. However, this does not remove the stimulus provided by spending the initial 1 million dollars, and the sale of the man's property will provide additional economic benefits to those who bought it, since bank foreclosure or seizure sales tend to be below market value. Foreclosed houses for instance can be bought cheap and flipped to provide a net economic boost to the buyer.

Now if the man's assets mysteriously were destroyed before the bank could recover the money, then the initial stimulus provided by the homeless dude spending the money is still there.

[mr friendly guy]

I know the initial stimulus would be expansionary for the economy. I know the bank's loss should also be contractionary. I am just wondering if it balances out, more than offsets the stimulus, or partially offsets the stimulus.

Which leads to interesting things people can do to stimulate the economy.

[Borgholio]

I'd say the stimulus outweighs the bank's loss of the money. The bank is mostly going to hang on to that money and not invest the full amount of it in private business the way actual spending is going to.

[Starglider]

I'd say the stimulus outweighs the bank's loss of the money. The bank is mostly going to hang on to that money and not invest the full amount of it in private business the way actual spending is going to.

On the contrary, the bank will try to invest every last penny of it, constrained only by legally mandated reserve ratios and/or core capital requirements. Exactly what they will invest it in is highly variable,

[Borgholio]

Would their investment have as big of an impact as spending a million on local businesses?

[Simon_Jester]

Depends on what they invest it in.

[Ziggy Stardust]

I think you could argue that the bank's investment has more POTENTIAL to be impactful than any one individual's spending patterns. Whether or not that potential is REALIZED is a function of what they actually invest in; without knowing enough about how finance works, I can't speculate on if bank investments are likely to realize this potential or not.

[mr friendly guy]

I can understand that the bank's investment would have more impact than a beggar's spending in future years, since the investment if done well will continue to generate income, well the spending directly only contributes for that particular year. However, unless the investment pays off in the same year, I would have thought the GDP would increase by the same amount. Perhaps an expert can shed more light.

[Simon_Jester]

I would think that it depends on whether the economy is more vitalized by having increased spending at existing businesses, by having money loaned to businesses, or by having new businesses created.

Obviously in some sectors and times creating and loaning to new businesses will have a higher multiplier effect. On the other hand, some things have a huge multiplier effect (e.g. investing in education for competent students).

[J]

It depends on which monetary model of the economy one is using, and the current state of said economy. For instance, in the current situation where most banks are holding large excess reserves (on paper, that is) and the velocity of money in the financial sector is quite low, all of the listed scenarios are stimulative. If, however, the velocity of money is normal or high, we then have to calculate the multiplier effect of the money as spent by the beggar and compare it with the average of what the bank achieves.