Friday, September 9, 2011

Discretionary Problem

A major problem with fiscal stimulus (government spending increases or tax decreases) is their discretionary nature. "Well, duh" you might say, but it does seem overlooked at times so I thought I'd write a post about it.

First, for those who might need a primer here, 'fiscal stimulus' refers to the federal government's ability to stimulate overall demand in the economy by increasing its spending or decreasing its taxes. Note the opposite is also true--gov'ts can 'destimulate' by decreasing spending or increasing taxes. There are two levers: taxes and spending. They can be used to increase demand or decrease it (there is debate over how effective each are, but that debate is outside the scope of this post and in fact part of the discretionary problem).

Our congressmen and president often disagree on composition of spending and levels of spending as well as on types of taxes and levels of taxes in general, but that problem comes to the fore when there is need for fiscal stimulus in times of low overall demand (the signs of which are unemployment, underutilized capital, know, just a bad looking the one we have now).

The time it takes for Congress to agree on stimulus measures and then the time it takes to implement those measures are major obstacles to the timeliness and benefits of the stimulus. The stimulus measures passed by Bush and Obama were largely ineffective because of their size, composition, and speed of implementation. All things that discretion create or worsen.

Spending and tax levers can be effective business cycle stabilizers, but the discretion government holds over them largely eradicates this potential and this is one of if not THE major argument of those who would rather government stay out of trying to 'fix' the economy. [This discretionary problem is also found in setting monetary policy and is why there is a debate among economists over whether the Central Bank should follow rules or use their own discretion to set interest rates].

Part of the attraction of my job guarantee proposal is that it eliminates a large part of the need for this discretion, first of all, by guaranteeing full employment and secondly, by tempering aggregate demand. Deficits (through both levers) would adjust to hold down aggregate demand in booms and prop it up during busts...automatically, without discretion.

Discretion would still hold sway over tax levels and types and over the composition and levels of government spending (and indeed over the program itself), but the need for discretionary fiscal stimulus would largely be eradicated. Politicians would be relieved of the burden of curing the economy and could focus on more important things such as deciding appropriate tax levels for different income groups or what government should even spend their money on to begin with, as well as social policies, international relations, etc.

I think that sounds pretty nice, what do you think?

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