Advanced industrial economies experience occasional periods of unemployment and recession. Government, the Congress, but mainly the president, ultimately will be held responsible. "Don't just stand there - do something."
Many conditions need to be in place for a fully employed, functioning economy, including, and especially, a broad range of private and public institutions. These are long-run propositions. What can be done in the shorter run?
After the Great Depression of the 1930s, followed by four years of wartime prosperity, the Congress passed, and President Truman signed, the Full Employment Act of 1946 that declared federal government responsibility to strive for full employment. Two primary sets of macroeconomic tools by which to stimulate the economy toward full employment are monetary policy and fiscal policy.
Monetary policy, executed by the nation's Federal Reserve System, is to influence short run interest rates, money supply, and availability of credit in the economy. This is a flexible set of tools, but only indirect, and asymmetric with respect to stage of the business cycle. (See May 16 column in The Monroe Times.)
Most economists insist that, though politically cumbersome, fiscal policy is a more direct and effective policy tool. Fiscal policy, the responsibility of Congress and the President, is use of government spending and taxing powers to influence the economy.
The logic of fiscal policy goes back to the fact that employment and output in a modern industrial economy depends on aggregate demand for goods and services. Whether because of bursting of financial bubbles, deficient returns to labor, loss of confidence, or deficient private sector spending for any reason, economies periodically go through periods of recession. Fewer goods and services are produced than the nation is capable of producing. Economists refer to this as a "GDP gap."
Aggregate demand in the economy consists of four components: Personal consumption (the largest of the four), private domestic investment (includes housing), net exports and government (at all levels) purchases of goods and services. The logic of fiscal policy is that if for whatever reason private spending declines, the federal government can step in and increase its spending to compensate for deficient private spending in an effort to maintain full employment.
A complementary step in expansionary fiscal policy is to reduce taxes. The logic is that reduced taxes leave more money in the hands of consumers for spending. This sounds good in theory, and is politically appealing. But the objective is to increase aggregate demand. Rather than tax cuts, economists prefer direct government spending to ensure that the money is circulated in the economy rather than saved and not re-circulated.
So does this mean that spending is good and saving is bad? Hey, c'mon - I'm Swiss, genetically and culturally predisposed to saving, and cautious about spending. So, here's the logic.
During recession, it is of course prudent for businesses to be cautious about spending. And, of course, consumers are ill-advised to spend beyond their means. Strengthening private sector balance sheets is sound business and household practice. But that's the whole idea behind countercyclical fiscal policy, government acting "against the cycle," spending on public needs while compensating for lack of private sector spending. The federal government is big enough to actually influence the economy through spending to compensate for deficient private spending.
But what about waste that is often associated with government spending?
We're all against wasteful spending, but our ideas on what is "waste" vary. I would start with wars that need not and should not be fought, and are counterproductive to our national security. And wars that are politically acceptable only because they are fought exclusively by volunteers instead of reluctant draftees.
Polls show that there are many federal expenditures on which most voters agree - increased funding for preschool children, rebuilding our decaying infrastructure, upgrading our national park system, increased aid to local government for water supply and sewage treatment, and basic scientific research. Recession and its aftermath is an ideal time to increase these expenditures - helps getting out of recession and is stuff we should be doing anyway, especially during periods of low interest rates.
But wouldn't this increase the annual federal deficit and the public debt?
Several points are relevant here. During recession, the deficit will automatically increase because of reduced tax collections. Any effort to "cut the deficit" through reduced federal spending during recession is doomed to failure. Instead of going against the cycle, cutting federal spending during recession reinforces the cycle by cutting aggregate demand and further reducing tax collections, increasing the deficit instead of reducing it.
The same logic counters the proposition occasionally voiced by critics, "If everybody else has to cut back and balance their budgets during recession, shouldn't the federal government abide by the same rules?" No, definitely not. Increased federal government austerity during recession would make the recession worse. However counter-intuitive, an unbalanced federal budget during recession is proper policy.
This brings us to the other side of countercyclical fiscal policy. As the economy improves and economic activity picks up, tax collections increase. Increased tax collections during economic expansion will reduce the annual deficit relative to size of the entire economy, if not eliminating the deficit entirely. Indeed, this is now happening, however slowly, although you wouldn't know it from the mainstream media. In the event of an economy expanding too rapidly, proper countercyclical policy would call for increased taxes and tempered government spending.
A "structurally balanced" budget is one for which total government receipts would equal total government expenditures with a full-employment economy, that is, zero annual deficit. A government surplus would enable reducing the public debt in absolute terms.
During the Clinton years, we had a structurally balanced budget, producing the now-forgotten budget surpluses. Incredibly enough, there was talk, not only of reducing the public debt, but, of paying it off entirely.
It didn't happen. After all, politicians will act like politicians.
Next week: The pernicious politics of countercyclical fiscal policy.
- John Waelti's column appears every Friday in the Times. He can be reached at jjwaelti1@tds.net.
Many conditions need to be in place for a fully employed, functioning economy, including, and especially, a broad range of private and public institutions. These are long-run propositions. What can be done in the shorter run?
After the Great Depression of the 1930s, followed by four years of wartime prosperity, the Congress passed, and President Truman signed, the Full Employment Act of 1946 that declared federal government responsibility to strive for full employment. Two primary sets of macroeconomic tools by which to stimulate the economy toward full employment are monetary policy and fiscal policy.
Monetary policy, executed by the nation's Federal Reserve System, is to influence short run interest rates, money supply, and availability of credit in the economy. This is a flexible set of tools, but only indirect, and asymmetric with respect to stage of the business cycle. (See May 16 column in The Monroe Times.)
Most economists insist that, though politically cumbersome, fiscal policy is a more direct and effective policy tool. Fiscal policy, the responsibility of Congress and the President, is use of government spending and taxing powers to influence the economy.
The logic of fiscal policy goes back to the fact that employment and output in a modern industrial economy depends on aggregate demand for goods and services. Whether because of bursting of financial bubbles, deficient returns to labor, loss of confidence, or deficient private sector spending for any reason, economies periodically go through periods of recession. Fewer goods and services are produced than the nation is capable of producing. Economists refer to this as a "GDP gap."
Aggregate demand in the economy consists of four components: Personal consumption (the largest of the four), private domestic investment (includes housing), net exports and government (at all levels) purchases of goods and services. The logic of fiscal policy is that if for whatever reason private spending declines, the federal government can step in and increase its spending to compensate for deficient private spending in an effort to maintain full employment.
A complementary step in expansionary fiscal policy is to reduce taxes. The logic is that reduced taxes leave more money in the hands of consumers for spending. This sounds good in theory, and is politically appealing. But the objective is to increase aggregate demand. Rather than tax cuts, economists prefer direct government spending to ensure that the money is circulated in the economy rather than saved and not re-circulated.
So does this mean that spending is good and saving is bad? Hey, c'mon - I'm Swiss, genetically and culturally predisposed to saving, and cautious about spending. So, here's the logic.
During recession, it is of course prudent for businesses to be cautious about spending. And, of course, consumers are ill-advised to spend beyond their means. Strengthening private sector balance sheets is sound business and household practice. But that's the whole idea behind countercyclical fiscal policy, government acting "against the cycle," spending on public needs while compensating for lack of private sector spending. The federal government is big enough to actually influence the economy through spending to compensate for deficient private spending.
But what about waste that is often associated with government spending?
We're all against wasteful spending, but our ideas on what is "waste" vary. I would start with wars that need not and should not be fought, and are counterproductive to our national security. And wars that are politically acceptable only because they are fought exclusively by volunteers instead of reluctant draftees.
Polls show that there are many federal expenditures on which most voters agree - increased funding for preschool children, rebuilding our decaying infrastructure, upgrading our national park system, increased aid to local government for water supply and sewage treatment, and basic scientific research. Recession and its aftermath is an ideal time to increase these expenditures - helps getting out of recession and is stuff we should be doing anyway, especially during periods of low interest rates.
But wouldn't this increase the annual federal deficit and the public debt?
Several points are relevant here. During recession, the deficit will automatically increase because of reduced tax collections. Any effort to "cut the deficit" through reduced federal spending during recession is doomed to failure. Instead of going against the cycle, cutting federal spending during recession reinforces the cycle by cutting aggregate demand and further reducing tax collections, increasing the deficit instead of reducing it.
The same logic counters the proposition occasionally voiced by critics, "If everybody else has to cut back and balance their budgets during recession, shouldn't the federal government abide by the same rules?" No, definitely not. Increased federal government austerity during recession would make the recession worse. However counter-intuitive, an unbalanced federal budget during recession is proper policy.
This brings us to the other side of countercyclical fiscal policy. As the economy improves and economic activity picks up, tax collections increase. Increased tax collections during economic expansion will reduce the annual deficit relative to size of the entire economy, if not eliminating the deficit entirely. Indeed, this is now happening, however slowly, although you wouldn't know it from the mainstream media. In the event of an economy expanding too rapidly, proper countercyclical policy would call for increased taxes and tempered government spending.
A "structurally balanced" budget is one for which total government receipts would equal total government expenditures with a full-employment economy, that is, zero annual deficit. A government surplus would enable reducing the public debt in absolute terms.
During the Clinton years, we had a structurally balanced budget, producing the now-forgotten budget surpluses. Incredibly enough, there was talk, not only of reducing the public debt, but, of paying it off entirely.
It didn't happen. After all, politicians will act like politicians.
Next week: The pernicious politics of countercyclical fiscal policy.
- John Waelti's column appears every Friday in the Times. He can be reached at jjwaelti1@tds.net.
