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Saturday, January 26, 2008

Andrew Samwick: A Better Way to Respond to Downturns

Here's Andrew Samwick on fiscal policy. I disagree with some of this, e.g. if you wait until you know if monetary policy works then it's too late for fiscal policy. Also, it's not clear that monetary policy works faster than fiscal policy. Monetary policy can be put into place faster than fiscal policy, but once in place it takes longer to impact the economy. When you put the implementation and effectiveness lags together, there is no necessary winner between the two types of policies.

In the post below this one on the same topic, I didn't do a very good job of separating the focus of the short-run stabilization policy (whether to try to change C, I, G, or NX) from its consequences (crowding out and crowding in), so let me try to clear that up here. I covered crowding out and crowding in the next post, so the focus here is on whether policy ought to be directed at C or I, or even G (G can be either consumption or investment; also, NX is harder to change, but policies can also be directed at NX, e.g. subsidizing exports).

Andrew recommends focusing on government investment when implementing stabilization policy. I have no problem with spending on infrastructure rather than giving tax rebates so long as such policies can be put into place quickly enough. Andrew's advance planning (see below) is supposed to make the policies easy to implement quickly, but I have some doubts about how well that would work, though I have also made the point that some of these projects are implementable on short-notice (and some, e.g. grants to state and local government, can prevent existing projects from being shut down and can be accomplished very quickly). I am less concerned with whether stabilization policy stimulates private consumption, private investment, or government investment than others seem to be, the important thing is to increase aggregate demand as fast as possible and get the economy moving again, and it doesn't much matter which component of aggregate demand, C, I, G, or NX is behind the stimulus. If you believe theory, which component is changed won't have much long-run impact on investment anyway. Real output growth is independent of demand changes in the long-run in most, but not all macro models. Demand shocks change short-run conditions, but the economy eventually finds its way back to the long-run path (assuming government provides the supporting infrastructure, but that doesn't have to be done with stabilization policy). Stabilization policy simply changes the speed at which you return to the long-run path, but its impact on the path itself is minor or non-existent. So the important thing is to get incentives or money to the people most likely to impact aggregate demand quickly which, fortuitously, is also happens to be the people most in need of help:

A Better Way to Deal With Downturns, by Andrew A. Samwick, Commentary, Washington Post: ...While politically expedient, the stimulus package is unjustified in the short run and harmful in the longer term. ...

The $150 billion agreement calls for tax rebates to low- and middle-income households as well as business incentives. Doubtless, this will boost economic activity. If you pull levers, you get movement. Personal consumption and business investment will increase relative to what they might otherwise have been. But there is no discussion of repaying the money through higher taxes in the near term. Let's drop the euphemism of "stimulus package" and call this agreement by its proper name: "deficit spending."

It is ironic that additional borrowing is prescribed as the remedy for a malady that arose from unwise borrowing. ... If we acknowledge that bad loans fueled the activity, why is it now a widely shared policy objective to maintain that level of activity?

The answer is a combination of three factors. The first is elected officials' fear that they will be punished in November for an economic downturn unless they do "something" to avoid it. Few things precipitate bipartisan agreement so quickly. Using the incomes of future taxpayers to purchase reelection today is irresponsible but common public policy.

The second factor is policymakers' fear that unless "something" is done, a temporary economic downturn could become more protracted. This fear, to the extent that it is justified, is better addressed by the Federal Reserve lowering short-term interest rates, which would stimulate the economy more quickly and comprehensively than would fiscal policy. The Fed did just this on Tuesday. Yet the fiscal-policy lever has been yanked before any data have indicated whether the Fed's stimulus has had its intended effect.

The third factor is the recognition that some households will bear a disproportionate burden of an economic downturn, combined with a belief that "something" should be done to help them. Government has a choice in whom it taxes to finance this relief -- other taxpayers today or all taxpayers in the future. That the agreement holds the former group harmless was also praised by Bush. This "stimulus bill" is really $150 billion worth of some future generation's resources appropriated to finance our own consumption. Why are we entitled to pass on this additional debt? ...

In political arguments, you can't beat something with nothing. But we can learn from this experience to have a better menu of fiscal policy options the next time around. Two changes to our budget policy would go a long way toward that goal.

First, we should rule out deficit spending to finance a consumption binge. As the economy slows, the deficit will widen even without changes in fiscal policy. But an honest budget policy would be calibrated to balance the budget over a complete business cycle. Years of cyclical deficits will be offset by years of cyclical surpluses. As a corollary, we must not waive pay-as-you-go rules that require spending that increases the current deficit to be offset later, when the economy is stronger.

Second, we can plan well in advance. The federal government has a critical role in maintaining and developing public infrastructure, whether in transportation, telecommunications or energy transmission projects. A sensible capital budget would include a prioritized list of projects that need attention. Some would be slated for this year, some for 2009 and so on, over the useful lives of the projects. When economic growth falters, the government would be in a position to move some of the projects from later years into the present year.

This approach to counter-cyclical fiscal policy has several advantages. Perhaps most obvious is that it forces the government to establish priorities for capital projects. It reduces overall expenditures by doing more of the work in times of economic slack, when costs are lower. It also abides by pay-go rules, since projects moved up to 2008 need not be done in 2009. With a little forethought, short-term economic concerns and long-term budget goals need not be in conflict.

    Posted by on Saturday, January 26, 2008 at 03:17 PM in Budget Deficit, Economics, Policy, Productivity, Taxes | Permalink  TrackBack (0)  Comments (20)

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