Role for Fiscal Policy and the Economic Outlook

Today Ben Bernanke testified on the rather dismal economic outlook before the Joint Economic Committee of U.S. Congress.

http://federalreserve.gov/newsevents/testimony/bernanke20111004a.htm

That might not be news, but in it, I thought Bernanke very clearly described how Fiscal policy should be implemented both in the short run and long run:

"To be sure, fiscal policymakers face a complex situation. I would submit that, in setting tax and spending policies for now and the future, policymakers should consider at least four key objectives. One crucial objective is to achieve long-run fiscal sustainability. The federal budget is clearly not on a sustainable path at present. The Joint Select Committee on Deficit Reduction, formed as part of the Budget Control Act, is charged with achieving $1.5 trillion in additional deficit reduction over the next 10 years on top of the spending caps enacted this summer. Accomplishing that goal would be a substantial step; however, more will be needed to achieve fiscal sustainability.

"A second important objective is to avoid fiscal actions that could impede the ongoing economic recovery. These first two objectives are certainly not incompatible, as putting in place a credible plan for reducing future deficits over the longer term does not preclude attending to the implications of fiscal choices for the recovery in the near term. Third, fiscal policy should aim to promote long-term growth and economic opportunity. As a nation, we need to think carefully about how federal spending priorities and the design of the tax code affect the productivity and vitality of our economy in the longer term. Fourth, there is evident need to improve the process for making long-term budget decisions, to create greater predictability and clarity, while avoiding disruptions to the financial markets and the economy. In sum, the nation faces difficult and fundamental fiscal choices, which cannot be safely or responsibly postponed."

Inflation and U.S. Federal Government Debt

Here is short interesting article from the St. Louis Fed about the possibility that the Federal Reserve might "monetize" the U.S. debt.

Fiscal Policy and Expected Inflation

Diarrhea-Constipation Cycle

Which school of thought do you belong to?

Here's Keynes' own take on managing business cycles and the digestive health of our children:

http://thinkmarkets.wordpress.com/2010/02/18/keynes-on-the-bismuth-castor-oil-cycle/

Multipliers

In ECO120 you learn about the multiplier. That concept has been used and misused. The Economist puts some of the recent debate about multipliers into context here.

The debate hinges on the scale of the “fiscal multiplier”. This measure, first formalised in 1931 by Richard Kahn, a student of John Maynard Keynes, captures how effectively tax cuts or increases in government spending stimulate output. A multiplier of one means that a $1 billion increase in government spending will increase a country’s GDP by $1 billion.

The size of the multiplier is bound to vary according to economic conditions. For an economy operating at full capacity, the fiscal multiplier should be zero. Since there are no spare resources, any increase in government demand would just replace spending elsewhere. But in a recession, when workers and factories lie idle, a fiscal boost can increase overall demand. And if the initial stimulus triggers a cascade of expenditure among consumers and businesses, the multiplier can be well above one.

The multiplier is also likely to vary according to the type of fiscal action. Government spending on building a bridge may have a bigger multiplier than a tax cut if consumers save a portion of their tax windfall. A tax cut targeted at poorer people may have a bigger impact on spending than one for the affluent, since poorer folk tend to spend a higher share of their income.

Crucially, the overall size of the fiscal multiplier also depends on how people react to higher government borrowing. If the government’s actions bolster confidence and revive animal spirits, the multiplier could rise as demand goes up and private investment is “crowded in”. But if interest rates climb in response to government borrowing then some private investment that would otherwise have occurred could get “crowded out”. And if consumers expect higher future taxes in order to finance new government borrowing, they could spend less today. All that would reduce the fiscal multiplier, potentially to below zero...

There is a lot more here.

Bailout Plan Summary

If you're wondering what's in the bailout plan passed by Congress this week, check out this summary.
http://money.cnn.com/2008/10/03/news/economy/house_bill_summary/