Dear Money...

     Should the government spend more money to stimulate the economy? Should the government spend less and let the private sector be the stimulus? The debate in the US rages back and forth.

     And then I found this article. Its from my macroeconomic class [so it may refer to "last chapter"], but I think it provides some good points against increasing government spending.

     Feel free to debate it.
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(from Gwartney & Stroup Macroeconomics 5th Edition)

Fiscal Policy 

What do we mean by the term fiscal? Merriam-Webster says that it comes from the Latin word fiscus, which means “basket” or “treasury.” It has come to mean anything pertaining to government financial matters. This can include government taxation, spending, and borrowing. All three of these areas of fiscal policy will affect the economy. Basically, changes in the government’s budget affect the overall economy. How so?

When the government spends more than it receives as revenue, there is a budget deficit. Assuming a constant money supply, the deficit is funded by borrowing. Typically, the US Treasury borrows by offering bonds.

When government revenues exceed government spending, there is a budget surplus. The surplus will reduce the government’s debt burden.

What causes the government’s budget to change? General changes in the economy affect both taxes and spending. Also, there may be intentional changes in government spending or taxation. This is called discretionary fiscal policy.

Last week we began our discussion of attempts to correct economic instability. This week our focus will be on attempts to use fiscal policy to affect the economy. You have already been introduced to Keynesian theory In general. Keynesian theory led the government away from the desire to balance the budget. Why would we want to balance the budget when we could simply change our spending habits to fix the economy?

The Keynesian view of fiscal policy is that the government can influence the economy by changing its budget. When we are in a recessionary period, a Keynesian would suggest that we should either increase government spending or reduce taxes. In other words, running deficits will help move us towards potential output and full employment. If inflation is becoming a problem, a Keynesian would suggest that reducing government spending or increasing taxes would put downward pressure on prices. So, running a surplus should help curb inflation.

If we have the tools to make it so, why isn’t our economic world perfect?

Crowding Out: reality sets in and spoils our noble ambitions…

This sounds like a nice simple idea, but there is a significant problem associated with borrowing to finance a government deficit. Do you remember our discussion a couple of weeks ago about how resource markets are interrelated with the overall market for goods and services? Government borrowing affects the demand for loanable funds. When the government needs to borrow funds to cover a deficit, it increases the overall demand for loanable funds. Other things constant, this pushes the price of loanable funds (the interest rate) upward. The higher interest rates will dissuade private spending. This scenario is referred to as crowding out. Thus the increased borrowing of the government crowds out the private sector from borrowing and spending. This makes the deficit-running fiscal policy less effective.

There is even more to this situation. Remember that higher interest rates will draw interest from foreigners who want to invest in dollar-denominated financial assets, thus making the US dollar relatively more valuable (appreciating against other currencies) and leading to a decline in net exports. (It will be more expensive to purchase goods with dollars.) So, the crowding out effect pretty much wipes out the intended effect of the policy. Whew! And we just thought we could run a little deficit and fix the economy… Oh boy, what a mess we have gotten ourselves into!


But wait, it appears there may be even more going on…

What if people realize that someone is going to have to pay for that new government spending? After all, we are no dummies. The New Classical view of fiscal policy argues that people will anticipate having to pay more future taxes due to current government spending and borrowing. This awareness will cause them to save more and spend less. The reduction in spending caused by increased savings will offset the deficit’s affect on the interest rate as well. Thus, the fiscal policy is really of no use. 

Even more discouraging news for those who would perfect the market via fiscal policy…

Do you remember how President G.W. Bush sent out checks to help stimulate the economy? Did you notice the time lag between reading about his intentions in the news and actually holding a check in your hand? That time lag is also a classic problem with discretionary fiscal policy. In fact, if it takes too long for a fiscal policy to actually be carried through, the result may be all wrong.

It should also be noted that there are some automatic fiscal stabilizers already in place. Unemployment compensation, corporate tax profit, and progressive income taxes work in opposition to the direction of the economy. When national output and income rise, unemployment compensation declines, corporate tax revenues increase and progressive tax revenues increases. On the other hand, when national output and income decline, unemployment compensation expenditures increase, corporate tax revenues decline and progressive tax revenues decline. So, these items tend to increase the budget deficit automatically during times of recessions and increase the surplus (or decrease the deficit) during expansions.


Could things get worse?

If you thought that you could fix the economy by implementing fiscal policies, I am sorry to disappoint you, but I must add this one last downside to the whole concept. I could sum it up in one word – politics. Politicians are motivated, as everyone else, by self-interest. For that reason, they will be much more likely to vote for expansionary policies than restrictionary policies. Politicians who vote for more spending are generally more popular than those who vote for restricting spending. This naturally makes deficit spending more likely, even when inflation is high.


Let’s sum it all up.

Here is the modern-day wisdom regarding fiscal policy:

· Timing is difficult and critical.

· Automatic stabilizers tend to move us towards potential output and full employment.

· Fiscal policy is not really that productive.

· All the demand-side policies we have discussed thus far will have differing results based upon all sorts of variables.


So, as time has passed, the potency of fiscal policy has come into question. Please be sure to pause a moment to review actual government budget figures which are presented in Exhibit 8. You may continue the graph in your own mind to include the massive spending of the recent years and imagine what sort of long-term effects may emerge from the current administration’s policies.

Debt Forgiving Debt...

An Egyptian woman adjusts her veil in front of a poster
outside an exchange office. (VOA)

           This past week, the United States grew close to finalizing a deal with Egypt’s new Muslim Brotherhood government and president, Mohamed Morsi, to help Egypt cut $1 billion from its national debt. Aside from the irony of one of the most debt-laden countries helping another nation pay off its own debt, the diplomatic move for the United States promises numerous benefits.

As the new Egyptian political system stabilizes, the Muslim Brotherhood ruling party has set its eyes on dramatically reducing the amount Egypt owes to foreign nations. This past month, President Morsi set off on a whirlwind tour of the world, not only re-establishing diplomatic relations with China, Syria, Russia, and the EU, but also requesting funds to help re-establish democratic relations within Egypt. Overall, Mr. Morsi’s requests have been successful with China pledging $270 million, the International Monetary Fund (IMF) throwing its support behind a $4.8 billion loan, and over $375 million invested by American financiers (in addition to the $1 billion provided by the American government). However, numerous Congressmen and taxpayers are wondering one thing: where does the money that President Obama pledged Egypt come from?

Where is the money coming from?

            The official explanation from Patrick Ventrell, the State Department’s acting deputy spokesman is that the $1 billion is not “new money.” And surprisingly, for once, the government seems to be correct. Like clockwork, the United States has given over $1.2 billion per year in military aid for the past few decades. Throughout the years, the account books have fluctuated back and forth until Egypt came out in the red—owing the US over $3 billion. Essentially, the money that the Obama administration is giving/forgiving out of the Egyptian debt is the money that would have gone to Hosni Mubarak for military support. In other words, the United States regularly gives Egypt $1 billion per year, so this deal is nothing new.

                        Except for the fact that the U.S. has already given Egypt millions this year. According to the 2012 Appropriations act signed by Obama in December 2011, the U.S. would only give to Egypt if the government was "supporting the transition to civilian government, including holding free and fair elections; implementing policies to protect freedom of expression, association and religion and due process of law." However, the act allowed the Secretary of State to waive that requirement, which Hillary Clinton did in March, increasing the amount donated to over $1.7 million per month given to Egypt.

The reason for the charity.

            As usual, there is a method behind the madness. Maintaining a strong U.S. presence within Egypt, either militarily or monetarily, is key to preserving Middle-East accessibility and Egypt-Israel solidarity, notes Patrick Ventrell. As the New York Times reports, given Egypt’s influence in the Arab world, officials said, its economic recovery and political stability could have a profound influence on other nations in transition and ease wariness in Israel about the tumultuous political changes under way.

            It is  an economic fundamental that nothing is free—you always have to give to get. In this case, the U.S. is trading money for security. One question remains unanswered and unasked however: do we even have the money to spend?

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Sources:

http://www.businessweek.com/news/2012-09-04/u-dot-s-dot-1-billion-debt-relief-plan-for-egypt-not-new-funds

http://www.nytimes.com/2012/09/04/world/middleeast/us-prepares-economic-aid-to-bolster-democracy-in-egypt.html?pagewanted=all

http://www.washingtonpost.com/world/middle_east/egypt-and-us-near-deal-on-debt-relief/2012/09/03/87b40dd8-f613-11e1-8b93-c4f4ab1c8d13_story.html