Selecting the Right Fiscal Policy

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Recent news indicates the economy’s overall growth rate has slowed and is falling short of expectations, with slower personal spending and weak job gains. This points toward the need for stimulative fiscal policy to encourage more private consumption spending, according to Diane Lim Rogers, chief economist for The Concord Coalition.

The key question in determining the best fiscal policies, she writes in a new blog post, is what binding constraints are on the economy at a particular time.

In a recovering economy still below full-employment level, Rogers says, “fiscal policy can increase GDP by stimulating consumption — either through the government’s direct purchases of goods and services, or through tax cuts or transfer payments that indirectly increase private spending.”

Temporary deficits in such situations may be justified. The effectiveness of such policies will largely depend on how well they are targeted towards households and businesses most likely to spend any additional funds.

In a fully-recovered, full-employment economy, however, the economy is constrained by the level of productive capacity. In that situation, increasing demand without increasing supply will only create inflationary pressures.

So as the economy gets closer to full employment, Rogers writes, “fiscal policy should transition from deficit-financed policies that encourage consumption, to paid-for policies that increase national saving.”

A recent analysis by the Congressional Budget Office of President Obama’s proposed budget underscores the distinction between the economy’s shorter-term and longer-term ailments. Rogers says the analysis also shows how higher deficits (relative to current law) would have different effects on these different ailments.   

“The latest economic news and the CBO analysis,” she writes, “serve as a reminder that any deficit reduction efforts over the next year need to be designed so as to not stifle personal consumption too much in the short term and yet substantially and credibly increase public saving over the longer term.”

In another recent development, the Department of the Treasury has reported that the government will record a surplus of $59 billion for April — the first monthly surplus since September, 2008.   Last April Treasury reported a $40 billion deficit.

Read more with The Economy’s Ailments and the Best Fiscal Policy Prescriptions

External links:
CBO: The Economic Impact of the President’s 2013 Budget
Monthly Treasury Statement
CBO: Monthly Budget Review

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