Monday, August 27, 2012

The myth of the "balanced approach" to fiscal policy

Glenn Hubbard and Tim Kane recently launched a new blog, "Balance: Why Great Powers Lose It and How America Can Regain It," that looks very promising. Here's an excerpt from their opening essay:

... we have two political parties and two approaches to the trillion-dollar budget deficit. The liberal approach is to raise taxes and the conservative approach is to slow the growth of government expenditures.
A smarter concept of fiscal policy balance is one that prioritizes outcomes (more jobs, faster growth, less poverty) over inputs. The goal of good fiscal policy is less about equating revenue with outlays and more about the fiscal mix which optimizes long-term prosperity. The fact that the liberal “War on Poverty” launched half a century ago has failed to make a dent in poverty is a sign of the government’s imbalanced thinking. Balance means putting incentives for job creation first, not good intentions to alleviate suffering.
This growth-oriented approach makes a lot of sense, and we can already see how. As the chart below shows, tax revenues have been rising for more than two years, without any increase in tax rates, and even though this recovery has been the weakest on record; revenues are up because more people are working, incomes are rising, and corporate profits are strong. Revenues always rise in a recovery, and the stronger the recovery, the more they rise. Meanwhile, federal spending has been almost flat since the recession ended, thanks largely to Congressional gridlock. (Though this happy combination is not likely to persist much longer if entitlement programs are not cut back.) For now, the result is a welcome decline in the deficit as a percent of GDP, from a high of 10.5% at the end of 2009, to 8.5% today. We have also seen a welcome decline in spending as a percent of GDP, from a high of 25.2% in Q3/09 to 23.5% today. Much more remains to be done, but it is not impossible at all.


Lawyer in NJ said...

This is just partisan spin. Alan Simpson himself said that Obama supports Simpson-Bowles, but since Republicans are against everything that Obama is for he can't say so publicly.

Republicans aren't interested in solutions, only naked power.

Foobar said...

This is pro-cyclical and lead to bigger booms and busts. Excessive growth is a very bad thing (tech bubble, housing bubble, etc.). We have many centuries of hard evidence.

Governments should shrink during good years and expand during bad years.

Why both the conservatives and the liberals so fixated on a fix growth trajectory for the government for all times? Why so obtuse?!

A side note, counter cyclical investing is also the winning long term strategy for investors.

William said...

Foobar could you expand on your comment:

"...counter cyclical investing is also the winning long term strategy for investors."

What do you mean exactly??

Thank you ,,,William

Benjamin Cole said...

By what fiction is the GOP a party that wants to slow federal spending?

Did this happen under Reagan? Bush? Bush jr? (the latter had majorities in House and Senate for much of his terms).

As a fraction of GDP, the federal government did shrink recently---in the Clinton years (who worked with a GOP House and Senate, truth to tell).

I wish the GOP walk would even come close to the GOP talk.

McKibbinUSA said...

Neither Republicans nor Democrats will cut spending by any significant margin -- in fact, history has shown repeatedly around the world that meaningful spending cuts never happen until government defaults and turnovers occur -- even with government turnovers, some sovereign debt still find its way into the new government's monetary calculus -- there's no hope for a balanced approach to leveling the budget -- there's every hope for a government default, even if that means a turnover of national government -- reality is that a US sovereign debt default is not only the fastest way to end deficit spending, a default is essentially the only way to achieve a balanced budget -- the victims of the coming changes will be those reliant upon government stipends and entitlements -- accredited investors and those with world-class skills will do just fine...

PS: Neither he big government Democrats nor the military-industrial Republicans have an intention of cutting spending in their respective camps -- in fact, there's not enough money in the world to satisfy their needs, desires, and wishes...

Ed R said...

If the GDP were 15% larger, the budget would almost be balanced, with no other changes in anything.

Public Library said...


Counter cyclical investing is when you manage capital such that during booms/busts your portfolio/business/country is not leveraged in all the wrong places.

For example, during the housing bust there were families with the dad in construction, mother in real estate sales, all the while owning two homes on cheap credit and little equity. When times were good, it was super good for this family. However, when the fat lady sung, it was lights out.

You can make the argument at the country level too. Look at Australia; riding the backs of the Chinese commodity boom. The industry dominates the Australian economy and capital investment. However, commodities are volatile. When the boom ends, if little was invested in other infrastructure and research, the domino effect will kick-in severely.

This is akin to managing against inverted balance sheets. It is wise to understanding your profile to avoid extreme highs and lows. There is much research coming out lately bursting the idea of higher volatility = higher returns. In fact, lower vol and higher quality assets outperform over the long haul.

SDH said...

Scott - thanks as always for your very helpful charts and analysis. I was hoping you would have time to explain or rebut the following chart, which continues to make the rounds of social media. Obviously it is flawed in comparing two years of deficits under Obama to 8 years under Bush, but even beyond that, the Bush deficit numbers are larger than what I find from other sources such as your blog and the Heritage Foundation. Is the NYT article simply incorrect, or are they playing games? Does it have to do with the counting of intragovernmental debts?

Scott Grannis said...

SDH: That NYT article and chart is full of assumptions that make no sense. For the unvarnished truth, I refer you to a post of mine last February. The numbers haven't changed since then. Bottom line, in four years Obama will have increased the federal debt burden by much more than Bush did in eight years.