Transcript Macroeconomics: Fiscal Policy

Macroeconomics: Fiscal
Policy,
Spending
Tools for Managing the Economy
 Again, fiscal policy is managing U.S. government
spending and taxing to affect the macro-economy.
Fiscal policy is the primary tool of Keynesian
economics, the dominant macroeconomic paradigm.
Fiscal policy is used to change aggregate demand and
investment.
 Control of the tools is not in the hands of any single
policy actor. Rather, economic policy making tends to
be decentralized, lacking coordination. The president
has more control over fiscal and regulatory policy than
any other actor. However, the president is not free to
work his will on the system.
Spending
 Some U.S. fiscal policy conducted through spending operates
automatically to stabilize and promote growth in the U.S. economy.
Unemployment, welfare spending, the progressive income tax.
 Other fiscal policy through spending is discretionary. “Discretionary”
is, however, somewhat of a misnomer. For the vast amount of public
expenditures and taxation, political actors have little discretion over
whether to spend money or not. Political actors tend to
systematically manipulate the economy in their own self-interest.
Political actors tend to focus on the short term, rather than plan
macro-economic policy for the long term. They suffer from limited
rationality in that they often fail to forecast the effects of changes in
spending and taxing. Moreover, the effects of fiscal policy depend in
no small part on the conduct of monetary and regulatory policy.
 Nevertheless, there is an apparatus at the national level
intended to rationally affect the macro-economy.
 The president is held largely responsible for macro-economic
policy management. The president depends for advice on
several policy actors including the Council of Economic
Advisors, the Office of Management and Budget, and the
Treasury Department.
 President’s Council of Economic Advisers- The three members
of the CEA and their staff are responsible for analysis,
forecasting, and estimating the impact of taxing and spending
changes on the economy. They are an advisory body. The
CEA serves entirely at the pleasure of the president, who may
appoint these members based on political preferences.
Provides advice only; knowledge is power. See
http://www.whitehouse.gov/administration/eop/cea.
 Office of Management and Budget-OMB is responsible for
formulating taxing and spending plans for the U.S. government. It
may assure that spending plans are consistent with the president’s
program. At any one time the OMB is formulating the next budget,
helping to execute the current budget, and auditing the last budget to
assure that the moneys have been spent efficiently and in
accordance with the law. OMB is a large federal bureaucracy that
interacts with other bureaucracies and the White House. Established
in 1921 as the Bureau of the Budget; reformed and renamed in 1970.
http://www.whitehouse.gov/omb
 Department of Treasury- Supervises revenue collection and provides
estimates of anticipated revenue to the president and CEA. One of
the original Cabinet Departments.
http://www.treasury.gov/Pages/default.aspx
 National Economic Council- Coordinates domestic and international
economic policy. Established in 1993. See
http://www.whitehouse.gov/administration/eop/nec
How Does Fiscal Policy Work?
 Again, fiscal policy is involved with the activities of government
that affect income, consumption, investment, taxation,
government spending, deficits, debt, saving, investment,
exports, and imports.
 Government Spending. Government expenditures include
money for bureaucratic salaries, equipment, technology,
welfare, social security, unemployment benefits, space
exploration, health care, etc. It also includes military
expenditures.
 Total Federal Expenditures through time.
National Defense
Non-Defense Expenditures
Welfare and Social Services
Note that the amount of discretionary spending is limited.
Where does all the money go?
Where does the discretionary money go?
Spending or Taxes?
 There are questions concerning whether it is better for the
economy for government to stimulate the economy through
reduced taxation or increased spending. Implicit in a tax
reduction is that individuals spend money, while implicit in
expenditures is that government spends it.
 This is more than a partisan issue that is debated by
Republicans who favor “no new taxes” versus Democrats who
prefer some government expenditures for collective goods at a
cost of larger government.
 Consider tax reduction as a means to economic recovery, as with the
1981 and 1986 Reagan tax cuts or 2001 and 2003 Bush tax cuts.
From our income flow diagram, a tax cut puts more money in the
income stream for consumers. Consumers have a choice about what
to do with this income. It is easy to see that they can 1) save it, 2)
spend it on foreign imports, or 3) consume goods in the domestic
market. If the goal is to prime the domestic pump in an economic
contraction, then there is no certainty that consumers will spend their
additional money in a compatible fashion, funneling their income into
either savings or imports. Thus, the consensus is that both the
Reagan and Bush tax cuts directed toward the wealthy did not have
their intended effects.
 Consider the effects of expenditures. Expenditures also add to the
income stream for consumers. Generally government spending is
targeted at specific sectors of the economy, such as the poor or the
middle class, as with the Kennedy tax cut finally implemented in 1964
or as with the Bush tax rebates in 2008 to combat the Great
Recession. High income groups got nothing, everyone else got
something.
 Consider also that the Reagan and Bush tax cuts were “supplyside” based on the “trickle-down” theory of macroeconomics.
That is, the tax cuts were directed at the wealthy and upper
income groups with the intention of stimulating investment,
which should have in turn stimulated economic activity.
 Did these tax cuts stimulate investment? Consider the following
graph constructed with data from the Federal Reserve Bank of
St. Louis.
 The vertical axis is U. S. private domestic investment as a
percentage of Gross Domestic Product.
Shaded areas are periods of economic recession.
 On the other hand, there is evidence that the Reagan tax cut
worked as a Keynesian-style stimulus to economic activity.
 See the next graph which presents the annualized quarterly
growth rate of GDP.
Shaded areas are periods of economic recession.
 Other examples, the depression era programs spent money on
public works and employment programs such as the WPA and
CCC. Spending programs in the 60s and 70s went toward
employment training and fostering jobs.
 Government spending is likely to be more compatible with the
nation’s goals in a recession since it can be targeted toward
redistribution toward those most hurt by a recession, the
unemployed and the poor.
 Thus, tax cuts may be less efficient than expenditures when
fighting a recession.
 The empirical evidence on the effects of taxation is mixed.
 The Kennedy tax cut finally implemented after his assassination
in 1964 sparked a decade long economic expansion.
 Clinton and the Democrats increased taxes on the highest
income groups in 1993, yet economic growth was significantly
higher than during the Reagan and Bush II years.
 The Reagan and Bush II tax cuts targeted toward the wealthy
were ineffective in stimulating robust investment and economic
growth in the 1980s and 2000s.
Real Annual Economic Growth by Presidency
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
Taxes, Spending, Debt, and Interest Rates
 There is also a catch to using either tax cuts or expenditures in a
counter-cyclical fashion, and that is the effect on the deficit and debt.
Again, if taxes are too low or expenditures too high, then government
must finance the difference through other means. The only way to do
this is through increased deficits and debt.
 However, when government finances a deficit it must borrow money
to do so. It effectively moves into the investment stream and
competes with the private sector for borrowing money. This
increases interest rates.
 Theoretically, higher interest rates can have two negative effects
beyond being a tax on people’s income: 1) higher interest rates
increase savings, which removes money from the income stream
(potentially offsetting the advantage of reduced taxes or government
spending), 2) they may also reduce investment since higher interest
rates due to government competition for money makes it more
difficult for private investors to borrow money.
Partisan Differences in
Macroeconomic Policy Effectiveness
 There do appear to be partisan differences to how well
fiscal policy is conducted between Republican and
Democratic administrations. The preceding bar chart
suggests an economic advantage to having a
Democrat in the White House.
 Let’s flesh this out more thoroughly.
Data From Business Cycle Dating Committee, National Bureau of
Economic Research
President
Truman
Truman
Eisenhower
Eisenhower
Eisenhower
Nixon
Nixon
Carter
Reagan
GHW Bush
GW Bush
GW Bush
Partisanship
Democrat
Democrat
Republican
Repubican
Republican
Republican
Republican
Democrat
Republican
Republican
Republican
Republican
Start Date
February 1945(I)
November 1948(IV)
July 1953(II)
August 1957(III)
April 1960(II)
December 1969(IV)
November 1973(IV)
January 1980(I)
July 1981(III)
July 1990(III)
March 2001(I)
December 2007 (IV)
Average Number of Recessions Starting During:
Democrats
3
Republicans
9
End Date
October 1945 (IV)
October 1949 (IV)
May 1954 (II)
April 1958 (II)
February 1961 (I)
November 1970 (IV)
March 1975 (I)
July 1980 (III)
November 1982 (IV)
March 1991(I)
November 2001 (IV)
June 2009 (II)
Duration In
Months
9
12
11
9
11
12
5
7
17
9
9
18
Average Duration of Recessions by Party
9.33
11.22
STATA Regression of Economic Growth on Presidential Party
STATA Regression of Unemployment on Presidential Party
STATA Regression of Inflation on President’s Party
Problems with Fiscal Policy as
Currently Applied
 Only a limited proportion of the budget is available for “priming
the pump.” The nature of expenditures, the obligation process,
means that the president has some control over what money is
spent when. However, most taxing and spending is regularized
and unavailable for manipulation of the macro-economy.
 In the short term, the limited proportion of the budget available
for “priming the pump” is subject to political decision-making.
That is, the president and Congress must agree on taxing and
spending changes.
 Increased spending or decreased taxation can be used to
either simulate consumer demand (Kennedy’s 1962 tax
reduction) or investment (the unrealized purpose of Reagan’s
1981 tax cut). However, there is a built-in politician bias toward
increased spending and decreased taxation. Rational control
of the economy may sometimes mean decreased spending and
increased taxation. Occasionally politicians do manage to
increase taxes in an effort to control the economy (e.g.,
Johnson and the income tax surcharge). However, generally
these tools of macro-economic management are not used.