Saturday, January 7, 2017

Fiscal Policy: Too Much of a Good Thing?

Oddly, it seems that fiscal arguments become an easier sell, when it's difficult to tell whether economic activity is actually in a strong position. Ed Dolan notes in a recent post that Republicans are anxious to once again ramp it up with fiscal policy. Should this in fact occur, would it be a "good thing"? Dolan responds:
Too much, in my opinion. Republicans like to portray themselves as the party of fiscal responsibility, but their record says otherwise. In practice, GOP budget policy so far this century has been consistently procyclical - expansionary when it should show constraint, contractionary when it should support a weak economy. All signs point to another procyclical episode in the making.
He provides a summary of recent fiscal policy, and adds:
Is the stage set now for the strongest dose of procyclical fiscal policy yet? That is a very real possibility. Tax cut fever is in the air. Despite the rhetoric of fiscal hawks, Congressional Republicans have, in the past, found it hard to resist demands to spend the revenue generated by economic expansion rather than using it to pay the debt. A bad record of fiscal policy may be about to turn ugly.
Should it all turn ugly as Dolan fears, how much procyclical fiscal policy might be due to an incoming president with an especially dominant personality? His post reminded me of an earlier dominant presidential personality, who allowed procyclical fiscal policy to become too much of a good thing, as well. Of LBJ, John Steele Gordon wrote in "An Empire of Wealth":
A decade older than Kennedy, Johnson was fully a son of the New Deal, one with deep faith that government could solve social and economic problems. He also possessed what were perhaps the most surpassing legislative skills of any American president. These skills had made him the most effective majority leader in the history of the Senate, and he was determined to use them to achieve what he saw as the completion of the New Deal of his political hero, FDR.
Gordon continues:
With the help of an overwhelming electoral victory in November that year, Johnson prodded Congress to pass bill after bill...Had the economy been underperforming as it had been in the 1930s, the result of all this new spending would have been stimulating. But the economy in the mid-1960s was near full employment, so the inevitable result was that inflation began to increase. A vicious circle quickly developed. Increased inflation caused interest rates to rise as lenders wanted protection from the inflation. But the Federal Reserve, operating on a Keynesian model, was afraid that increased interest rates would cause economic growth to end, and so it expanded the money supply to keep interest rates low. An increased money supply, relative to the goods and services the money could buy, ineluctably caused further inflation.
One has to wonder, if the Federal Reserve were as worried about potential for stalled growth in Lyndon Johnson's time, as Gordon assumed. Nevertheless the Fed doesn't appear particularly worried about stalled growth now. After all, it has announced intentions to raise interest rates several times this year, apparently, irrespective of how Trump might affect economic conditions.

Perhaps the inflation question is also difficult to answer, since fiscal approaches are subject to wide variance in outcome. For one, government efforts this time around may prove more likely to benefit business interests, than demographic groups. That said, inflation could be more extensive, should infrastructure investment turn out to be mostly additional options to what the intended recipients already rely on. Yet growth and greater productivity is more likely to occur, if fiscal policy benefits groups who consequently gain more economic access, than they had prior to fiscal stimulus. Might the Fed also doubt the ability of fiscal stimulus to translate into real economic gains? A quote from a recent Atlantic article, could provide a clue:
Policy is much better at redistributing money to individuals than it is at revitalizing regions.

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