A Kennedy-Reagan-Trump Fiscal Policy?

A Kennedy-Reagan-Trump Fiscal Policy?

Heather Long reports that the White House economists have no clue about the history of U.S. fiscal policy:

President Trump’s policies are driving an economic turnaround that puts him in the company of transformative presidents such as John F. Kennedy and Ronald Reagan, White House economists said Wednesday as they unveiled their first “Economic Report of the President.” The report presents a highly optimistic view of the economy’s current condition and future course, with growth predictions that exceed most nonpartisan economists’ expectations. Economists also caution the White House’s efforts to juice growth could cause the economy to overheat and then careen into a downturn.

Brad DeLong asks whether his latest on fiscal policy and long-term growth belongs in the next edition of Martha Olney’s and his macroeconomics textbook? While I say it should, permit me to quote the relevant passages after I inform these clueless White House economists about fiscal policy during the 1960’s and under Reagan as I noted over at Brad’s place:

We did get that 1964 tax cut right after Kennedy died and we did ramp up defense spending for Vietnam. In December 1965 Johnson’s CEA had the good sense to tell him that we had gone overboard with fiscal stimulus. Alas we got the 1966 Credit Crunch anyway followed by an acceleration of inflation when the FED backed off on its restraint. Reagan gave us a similar fiscal policy but the Volcker FED did not back off its tight monetary policy so we got the mother of all crowding out – high real interest rates for years and a massive currency appreciation. Glad to see that Trump’s CEA has compared this fiscal fiasco to the previous mistakes. Oh wait – Kevin Hassett thinks this is good fiscal policy. It seems the current CEA is as stupid as the President it advises!

OK – now that I’m done with my rant and little history lesson, let’s hear from Brad:

In late 2017 and early 2018 the Trump administration and the Republican congressional caucuses pushed through a combined tax cut and a relaxation of spending caps to the tune of increasing the federal government budget deficit by about 1.4% of GDP. These policy changes were intended to be permanent. Not the consensus but the center-of-gravity analysis by informed opinion in the economics profession of the effects on long-run growth of such a permanent change in fiscal policy would have made the following points: 1. The U.S. economy at the start of 2018 was roughly at full employment, or at least the Federal Reserve believed that it was at full employment and was taking active steps to keep spending from rising faster than their estimate of the trend growth of the economy, so a long-run Solow growth model analysis would be appropriate. 2. The economy’s savings-investment effort rate, s, has two parts: private and government saving: s=sp+sgs=sp+sg. 3. The private savings rate spsp is very hard to move by changes in economic policy. Policy changes that raise rates of return on capital—interest and profit rates—both make it more profitable to save and invest more but also make us richer in the future, and so diminish the need to save and invest more. These two roughly offset. 4. Therefore, when the economy is at full employment, changes in overall savings are driven by changes in the government contribution: Δs=ΔsgΔs=Δsg. 5. And an increase in the deficit is a reduction in the government savings rate.

Brad continues using the Solow growth model to demonstrate how the latest fiscal fiasco would lead to less capital per worker over time reducing steady state output, which is what we witnessed in the 1980’s. We have been asking the same question since 1981 – how can anyone argue that a fall in national savings is good for long-term growth? We still have not received a coherent answer.


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