Two basic sets of policy tools with which the federal government can affect the macro economy are monetary policy, executed by the Federal Reserve System, and fiscal policy, executed by Congress and the president.
Monetary policy is influencing short-term interest rates, money supply and availability of credit. Fiscal policy is the use of government spending and taxes as it affects employment and national economic output.
Monetary policy is indirect, acting through short-term interest rates. It is asymmetric with respect to stage of the business cycle - a tight monetary policy will discourage borrowing while an expansionary monetary policy with low interest rates does not ensure that businesses and consumers will increase their borrowing and spending (see Times column, May 16).
Most economists believe fiscal policy to be more direct and powerful as to effect on employment and output. A countercyclical fiscal policy has the federal government, during recession, implementing an expansionary fiscal policy with some combination of increased government spending and reduced taxes. During an expanding, and perhaps overheated, economy, countercyclical fiscal policy calls for a contractionary fiscal policy consisting of restrained government spending and increased taxes, intended to cool the economy down and prevent inflation (see Times column, May 23).
An advantage of monetary policy is that it is more flexible in the sense that it can be used frequently and with varying degrees, depending on the situation. As it is implemented by the Federal Reserve System, it is one step removed from direct partisan politics which can be an advantage or disadvantage depending on how one looks at it. Its chief disadvantage is that it is only indirect, taking time for changes in short-term interest rates to affect the economy significantly.
In contrast, fiscal policy is far more direct and powerful. But it is inflexible and difficult to change. As changes in the business cycle are difficult to predict, proper timing of fiscal policy is difficult, at best. As economist Paul Samuelson once observed, "Economists have predicted 10 of the last five recessions," or words to that effect.
Once in recession, it is obviously time for an expansionary fiscal policy. But there are other problems. As fiscal policy is executed by Congress and the president, it is necessarily political. Taxing and spending become tied up with political decisions and philosophy other than merely getting out of recession.
With expansionary fiscal policy consisting of increased government spending and tax cuts, tax cuts naturally are more politically expedient, though less effective. As the objective is to increase government spending to compensate for deficient private spending, economists would recommend direct government spending to get additional money into circulation. Especially if the tax cuts are for the more affluent, money left to individuals through tax cuts might be not spent, or spent on items such as foreign imports, bidding up the price of prime beachfront land or scenic ranch land in the mountain west, all of which do nothing to achieve the objective of increased domestic employment.
Perhaps the biggest problem with severe tax cuts during recession is that, even if intended to be temporary, they become permanent, even when responsible policy would call for higher taxes either to pay for legitimate government expenditures or to counter an overheated economy. As we have seen, political campaigns are never a productive forum for discussing spending and tax policy.
Increased government spending during recession is a hard sell. It will likely increase the annual federal deficit, at least temporarily - a logical outcome during recession. But it is tough to counter the notion that if individuals and other units of government have to tighten up, the federal government should also. But the point of countercyclical fiscal policy is to counter the deficiency of spending in the rest of the economy. The proper time to seriously reduce annual deficits is during full employment and a rapidly expanding economy. Actually, the current deficit is falling, even with this very slowly expanding economy.
Critics of government spending complain of waste. Yet there are important federal expenditures on which nearly all agree. Furthermore, the waste we should be concerned about, but is generally ignored, is the unemployed labor and idle plant capacity that are not producing the goods and services that could be produced in a fully employed economy. That is major waste about which we should be more concerned.
If the politics of an expansionary fiscal policy are difficult, the politics of a contractionary fiscal policy, tax increases and expenditure cuts, during prosperity are even more contentious. No politician wants to advocate increased taxes even though responsibility demands meeting financial obligations.
For those who despair of increased deficits during recession, it is during prosperity with increased tax collections and legislated increased tax rates, especially on the affluent benefiting most from prosperity, that annual deficits can be eliminated. With budget surpluses, the public debt could be reduced, both relative to size of the total economy and in absolute terms.
The nation was in perfect position to do this with the now-forgotten budget surpluses accumulated during the Clinton administration. But during the following administration, we heard nothing from either the president or Congress about paying down the debt "for the sake of our children." The line handed to us was "these surpluses are your money. We're going to hand it back to you - right now - as tax cuts."
Those tax cuts were largely geared to the nation's most affluent, further exacerbating the disparity in the nation's wealth and after-tax income. An opportunity to reduce the public debt, if for no other reason than to provide political cover for deficits required (and for all practical purposes, inevitable) during the following Great Recession, was irresponsibly squandered.
But again, fiscal policy is executed by Congress and the president, a necessary condition of democracy and "taxation only with representation."
We can expect politicians to act like politicians.
- John Waelti's column appears every Friday in the Times. He can be reached at jjwaelti1@tds.net.
Monetary policy is influencing short-term interest rates, money supply and availability of credit. Fiscal policy is the use of government spending and taxes as it affects employment and national economic output.
Monetary policy is indirect, acting through short-term interest rates. It is asymmetric with respect to stage of the business cycle - a tight monetary policy will discourage borrowing while an expansionary monetary policy with low interest rates does not ensure that businesses and consumers will increase their borrowing and spending (see Times column, May 16).
Most economists believe fiscal policy to be more direct and powerful as to effect on employment and output. A countercyclical fiscal policy has the federal government, during recession, implementing an expansionary fiscal policy with some combination of increased government spending and reduced taxes. During an expanding, and perhaps overheated, economy, countercyclical fiscal policy calls for a contractionary fiscal policy consisting of restrained government spending and increased taxes, intended to cool the economy down and prevent inflation (see Times column, May 23).
An advantage of monetary policy is that it is more flexible in the sense that it can be used frequently and with varying degrees, depending on the situation. As it is implemented by the Federal Reserve System, it is one step removed from direct partisan politics which can be an advantage or disadvantage depending on how one looks at it. Its chief disadvantage is that it is only indirect, taking time for changes in short-term interest rates to affect the economy significantly.
In contrast, fiscal policy is far more direct and powerful. But it is inflexible and difficult to change. As changes in the business cycle are difficult to predict, proper timing of fiscal policy is difficult, at best. As economist Paul Samuelson once observed, "Economists have predicted 10 of the last five recessions," or words to that effect.
Once in recession, it is obviously time for an expansionary fiscal policy. But there are other problems. As fiscal policy is executed by Congress and the president, it is necessarily political. Taxing and spending become tied up with political decisions and philosophy other than merely getting out of recession.
With expansionary fiscal policy consisting of increased government spending and tax cuts, tax cuts naturally are more politically expedient, though less effective. As the objective is to increase government spending to compensate for deficient private spending, economists would recommend direct government spending to get additional money into circulation. Especially if the tax cuts are for the more affluent, money left to individuals through tax cuts might be not spent, or spent on items such as foreign imports, bidding up the price of prime beachfront land or scenic ranch land in the mountain west, all of which do nothing to achieve the objective of increased domestic employment.
Perhaps the biggest problem with severe tax cuts during recession is that, even if intended to be temporary, they become permanent, even when responsible policy would call for higher taxes either to pay for legitimate government expenditures or to counter an overheated economy. As we have seen, political campaigns are never a productive forum for discussing spending and tax policy.
Increased government spending during recession is a hard sell. It will likely increase the annual federal deficit, at least temporarily - a logical outcome during recession. But it is tough to counter the notion that if individuals and other units of government have to tighten up, the federal government should also. But the point of countercyclical fiscal policy is to counter the deficiency of spending in the rest of the economy. The proper time to seriously reduce annual deficits is during full employment and a rapidly expanding economy. Actually, the current deficit is falling, even with this very slowly expanding economy.
Critics of government spending complain of waste. Yet there are important federal expenditures on which nearly all agree. Furthermore, the waste we should be concerned about, but is generally ignored, is the unemployed labor and idle plant capacity that are not producing the goods and services that could be produced in a fully employed economy. That is major waste about which we should be more concerned.
If the politics of an expansionary fiscal policy are difficult, the politics of a contractionary fiscal policy, tax increases and expenditure cuts, during prosperity are even more contentious. No politician wants to advocate increased taxes even though responsibility demands meeting financial obligations.
For those who despair of increased deficits during recession, it is during prosperity with increased tax collections and legislated increased tax rates, especially on the affluent benefiting most from prosperity, that annual deficits can be eliminated. With budget surpluses, the public debt could be reduced, both relative to size of the total economy and in absolute terms.
The nation was in perfect position to do this with the now-forgotten budget surpluses accumulated during the Clinton administration. But during the following administration, we heard nothing from either the president or Congress about paying down the debt "for the sake of our children." The line handed to us was "these surpluses are your money. We're going to hand it back to you - right now - as tax cuts."
Those tax cuts were largely geared to the nation's most affluent, further exacerbating the disparity in the nation's wealth and after-tax income. An opportunity to reduce the public debt, if for no other reason than to provide political cover for deficits required (and for all practical purposes, inevitable) during the following Great Recession, was irresponsibly squandered.
But again, fiscal policy is executed by Congress and the president, a necessary condition of democracy and "taxation only with representation."
We can expect politicians to act like politicians.
- John Waelti's column appears every Friday in the Times. He can be reached at jjwaelti1@tds.net.
