Part 2 of 3. Part 1 appeared Jan. 18.
This is the second column in a three-part series discussing the factors that control the economy and the role that the president plays in steering the economy. There are several principles at play that must be understood — monetary policy, fiscal policy, fiscal lag and the economic consequences to certain executive branch actions taken by the Treasury Department or the president.
My previous column discussed how monetary policy affects the economy. This column will delve into fiscal policy.
The International Monetary Fund defines fiscal policy as “the use of government spending and taxation to influence the economy.”
In the Unites States, our Constitution gives the purse strings to Congress.
As previously discussed, the Fed has three tools to implement monetary policy. Congress similarly has three tools to carry out fiscal policy — government spending, taxes and transfer payments from the government to others.
As with monetary policy, there are expansionary and contractionary fiscal policies.
When the economy is at the bottom of the economic cycle, overall spending is reduced and there is less economic activity.
This is when Congress will supplement private spending with government spending and will reduce taxes to give the private sector more money to spend. Congress will also frequently enable transfer payments to subsidize targeted economic activity by the private sector. Typically expansionary fiscal policies involve deficit spending followed by an increase in national debt.
When I took economic courses in college 50 years ago, we were taught that, after the economy recovers from a recession, governments reduce spending and raise taxes to repay the debt incurred in the recession. While that may have been true at one time, since I took those courses I have yet to see that on a sustained basis.
Our national debt now exceeds $34 trillion — an amount that is unsustainable over the long term. Failure to realign fiscal policy with an improved economy is inflationary, according to economic theories — particularly when the Fed concurrently pursues expansionary monetary policies.
In 2017, at the peak of the economic cycle, when the government theoretically should have increased taxes or reduced spending, Congress passed a $1.5 trillion tax cut. In the late stages of the pandemic, Congress passed legislation calling for extensive unfunded transfer payments and tax cuts that probably exceeded what was needed to revive the economy during the pandemic. Paycheck Protection Program loans and Employee Retention Credits are great examples of transfer payments that were relatively easy to obtain.
There is one other aspect of expansive national debt that is troubling.
Increased debt means higher interest expenditures for the government. When expansive monetary policy is pursued and interest rates are near zero, the interest cost does not change much, while the debt soars. But when monetary policy tightens and interest rates surge, the incremental interest costs can crush the economy because either government funds are redirected away from expenditures that stimulate the economy or taxes must be raised to fund the costs, which also redirects funds from the private sector.
The problem with contractionary fiscal policy is that it is unpopular with voters. Congress does not want to run for reelection on a platform of increased taxes.
Moreover, both special interests and large voting blocks like to receive transfer payments.
Consequently, Congress cannot deal with debt that is out of control.
In most counties, once spending is authorized by the government, payment of the expenditures is automatically authorized as well. When you charge an expenditure to your credit card, you agree to repay the bank for the amount spent.
In America, Congress separately authorizes expenditures, followed by the authorization to issue debt before the debt-financed expenditures can be paid.
This affords Congress the opportunity to grandstand about funding the previously authorized expenditures to create the appearance of trying to reduce the national debt.
Unlike other countries, this provides yet another wrinkle in the administration of fiscal policy.
Because of the political dynamics involved with administering fiscal policy, it is much more difficult to target fiscal policies to effectively deal with the economy than it is to target monetary policies. It is much easier for the Fed to raise interest rates than it is for Congress to raise taxes.
The final column of this series will focus on the concept of fiscal lag, its political implications and what economic actions the president can take.
Jim de Bree is a Valencia resident. If you are interested in learning more about this topic, College of the Canyons offers the course, “ECON 201, Macroeconomics.”