Discretionary Fiscal Policy: Bah, Humbug
I feel like Scrooge in opposing discretionary fiscal policy.
- It seems that politicians are eagre to implement stimulative fiscal policy all the time, but during periods of low unemployment and potentially rising inflation rates, we never seem to hear much about how we need to raise taxes or, more importantly, cut back on gubmnt spending (especially of the pork-barrel type) to slow down an over-heating economy. Where were all the fiscal Keynesians in 2005 - 2007?
- Are there any electable politicians who think the size of the gubmnt is too large? Are there any electable politicians who distrust placing authority and discretion in the hands of politicians and bureaucrats? And why is that so many people who distrust current politicians or bureaucrats think that replacing them or worse, adding to them, would make things better?
- I, for one, am a bit (but not entirely) skeptical of the Ricardian Equivalence (named for its discoverer, Professor Equivalence) argument against stimulative fiscal policy. Russ Roberts explains the concept clearly in this snippet from a fictitious dialogue,
Well, if the government isn't going to cut spending (and they're not, because that would offset the stimulus of the tax cut, wouldn't it?), then it's going to have to borrow all the money to cover its spending for this year. The bonds the government sells are going to have to be repaid. We're going to have higher taxes next year and the year after. I think we better put that $16,000 aside to pay for those taxes.
The idea is that any time the gubmnt increases its debt to stimulate the economy, there is an equivalent reduction in spending as people save more for the increased tax liability. Maybe. But I'm not so sure people think that way.
Several years ago, a colleague asked me, "When the federal debt rises, don't you start saving more for the anticipated tax bill?" He was absolutely stunned when I said, "No, I start spending more so I won't have anything left to tax when I get older. You keep saving, though, so you can pay the taxes to help look after me."
- And what prompted this posting: I've been teaching for years that the lag in implementing discretionary policy is almost always far too long for such policy to be useful.
The recognition lag (recognizing that recession is imminent) is often 6 - 12 months. We're often well into it before enough decision-makers agree that we are into it that anything that might be useful can be done.
Then there is the decision lag, the time during which politicos and others argue/debate/logroll/negotiate about whether and what to do. This lag can be anywhere from 3 to 9 months, or longer. And sometimes the hodge-podge of results is downright disgusting (see Clinton's "Christmas Tree" of recommendations for fiscal stimulus).
That's followed by the implementation lag ; this lag occurs because even once a policy is agreed upon, it takes awhile to implement it. The gubmnt cannot cut rebate cheques overnight. Tax cuts cannot be put into place overnight. And stimulative gubmnt spending usually takes much longer to implement. The lag is anywhere from a month or two up to maybe 6 - 8 months.
And finally, there's the effect lag . Once implemented, the policies take awhile to have any stimulative effect. The Keynesian multiplier does not work overnight to its fullest extent (assuming you think the multiplier is anything other than zero anyway!). This lag can be anywhere from 3 months to a year!
Overall and taken together, the combination of these lags can be so long that by the time the policy takes effect, we're well past the trough of the recession and possibly into a boom period, when we no longer need the stimulus (note that the lags are often much shorter for discretionary monetary policy, though even there as Milton Friedman once said, the lag is "long and variable".).
For some confirmation of the problem of lags, check out this op-ed column in today's NYTimes:
The history of anti-recession efforts is that they are almost always initiated too late to do any good. This chart [a graphic in the original article], based on recession timelines from the National Bureau of Economic Research, shows the enactment of stimulus plans is a fairly accurate indicator that we have hit the bottom of the business cycle, meaning the economy will improve even if the government does nothing.
Category: Economics, Macroeconomics, Money Posted on
Wednesday, January 23, 2008 at 1:31pm
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As a big believer in the NAIRU and disequilibrium macro, you should be at least skeptical. What am I missing.
You're 100% right on the lags and the public choice aspect of it all.
Even so, we can think of disastrous times when the above disadvantages of a fiscal stimulus would be outweighed by the benefits. If the bullseye is big enough, even the coarse, shaky hand of government can hit it.
Ricardian Equivalence however may not work if people are borrowing-constrained. Maybe that's what you were thinking of.