The Weak Economy and Presidential Politics: Could Someone Tell RUDY About the Balanced Budget Multiplier?

With all the recent talk about combating the supposed oncoming recession, Adam Nagourney ponders whose candidacies this will help most and suggests this will help Romney and Clinton. Why Romney? Well I guess the public thinks a business background means one makes great economic decisions (banging my head against the wall). And Senator Clinton was First Lady when Bill Clinton convened and actually listened to some very good economic advice (more on this later).

Nagourney notes that some Republicans want fiscal stimulus in the form of tax cuts, while some Democrats want more government spending. Senator Obama’s call for tax rebates has me wondering whose nomination he is really seeking. As we talk about deficit financing, we should give Andrew Samwick some time at the microphone:

Forget the “stimulus” label, this is merely additional deficit spending. There is no discussion of repaying the money through higher taxes in the near term. Based on the President’s remarks this morning, the deficit bill will be for about $150 billion. So this proposal is just another $150 billion of some future generations’ resources that we will be using for our own consumption today. Why are we entitled to pass them this additional debt?

But then there’s RUDY who may sort of be listening to Dr. Samwick:

Former Mayor Rudolph W. Guiliani of New York was more sketchy as he answered questions about how he would handle the financial upheaval. Addressing a reporter he knew from New York, he pointed to his experience as mayor in suggesting that he was prepared to handle the crisis, but offered no details on what he thought should be in a stimulus package, or what taxes should be cut. “Congress and the president should do a stimulus package and they should do a spending reduction package,” he said. “You’re familiar with that; we used to do that in New York.”

Cutting government spending is not demand stimulus. Of course, RUDY wants to cut taxes but does he not get the balanced budget multiplier, which basically says that if we cut government spending by the same amount as we reduce taxes, then aggregate demand will decline.

OK, back to the Clinton era of Rubinomics where the policy dilemma was how to cut the deficit but also stimulate aggregate demand. One idea, which I’d hope someone might float, might be to accelerate government spending programs but not increase long-term government spending. We might also try to backload any tax increases. The idea would be to move the sum of private and public consumption forward as we promise to those who are making investment decisions that we will get our fiscal house in order and hopefully later increase national savings. That might actually encourage investment rather than crowd it out.

Andrew Samwick is not alone in his disdain for fiscal stimulus as the primary tool for increasing aggregate demand as Greg Mankiw has had several excellent posts on why we should be relying more on monetary policy. Greg even found a 1994 quote from Paul Krugman:

When monetary expansion is ineffective, fiscal expansion…must take its place. Such a fiscal expansion can break the vicious circle of low spending and low incomes, “priming the pump” and getting the economy moving again. But remember this is no by any means an all-purpose policy recommendation; it is essentially a strategy of desperation, a dangerous drug to be prescribed only when the usual over-the-counter remedy of monetary policy has failed.

A dangerous drug indeed and if we took the medicine prescribed by Dr. RUDY, it would have the opposite of what is the desired effect.