Thursday, July 14, 2016

Ending Fiscal Stimulus: A Case For Sensible Fiscal Policy

Whenever the economy isn’t doing so well, the talk inevitably turns to fiscal stimulus. This usually means proposals for some kind of infrastructure improvements – often long overdue – and a preference for so-called “shovel-ready” projects that are intended to move money into the economy quickly (whether they do or not is another matter). Such proposals are often attacked as too slow to have any effect, or being poorly planned and resulting in wasted spending or even graft.

Anyone who has been following my posts for long will know that I am a proponent of significant investment to develop national capital (infrastructure, health, research, education, ecology, arts, etc.), but here I would agree that infrastructure is a poor economic stabilizer and provides weak stimulus in the near term when it is most needed. Infrastructure and other investments should be made if and when such projects are needed or deemed beneficial to the nation, not because the economy needs a kick-start.

When the economy is in a downturn then businesses and households increase their savings, sales and revenues fall, investment is cut back, and unemployment rises as companies cut costs. But while our politicians and pundits debate stimulus packages something else is already going on: a powerful government fiscal response kicks in all by itself (as it was designed to do).

What is happening is that the government is adding more spending power into the economy than it removes via taxation. Tax payments drop due to slower sales and lower incomes; simultaneously there is an increase in unemployment and welfare payments which add money directly into the economy. Such targeted spending is mostly spent by those in need, increasing sales for businesses and slowing the economic decline. These intentional net increases of government monetary contributions to the economy are what economists call automatic stabilizers, and they are the main reason we don’t have regular great depressions. It is also a major reason why the government “deficit” and “debt” rise during recessions and fall during economic expansions (as much as Presidents from both parties love to take credit!)

It should be obvious from this that we could do a better job of designing our automatic stabilizers to optimize their effect in maintaining a healthy economy during downturns. We can do much more to shorten a recession and maintain employment and incomes for people during times when businesses are struggling. Too little attention has been given by economists to analyze what tax structures and progressive rates will act best to stabilize our economy during business cycles to more effectively maintain a fully productive and employed economy. But there is a bigger problem with our approach.

Fiscal stimulus is simply the wrong paradigm. We need currency management.

There is a more fundamental issue with how we discuss responses to the economy and what is in the public interest. The term “fiscal stimulus” betrays an ignorance of our currency and appropriate fiscal policy.

The idea behind fiscal “stimulus” is that the economy is a big market that operates generally on its own, but once in a while it can get stuck. It is during these times that the government can step in temporarily to help give it a push start. But otherwise, the government should behave like all other market participants and not "intervene".

This framework is erroneous for many reasons, but most fundamentally, it ignores the fact that the national government is the sole issuer of the nation’s currency. The currency-issuer plays a unique and vital role in the overall economy in addition to the government's role of issuing currency to fulfill public purpose. The management of the currency must also take into effect the changes in the demand for its currency that occur during ebbs and flows in the economy. Failure to do so results in painful results for portions of the population.

Public Purpose

The reason why the typical nation has its own currency is to fulfill public purpose in ways that markets can never do and that meet the needs of its inhabitants: provisioning for defense, building infrastructure, investing in long term research, providing incomes for the elderly and education for the young, etc. Via our democratic process and representative government, decisions are made as to what the government should pay for. This defines the base budget which sets the amount of its currency the government is expecting to add into the economy during a given time-frame.

Currency Management

While we have a basic tax structure that generally removes a large amount of this newly-added currency back out of the economy, effective currency management becomes critical at this stage. If the government taxes too much out, then it will create unemployment. If it leaves too much in there can be periods of unwelcome levels of inflation. And all of this is also affected by the trade balance (how much currency is being saved abroad), along with the general state of the domestic economy (heavily influenced by levels of private credit growth).

Imagine a Public Water Utility that exclusively serves a city and has an unlimited source of water (just as the government has an unlimited ability to create its currency). If some residents started building bigger swimming pools and some businesses began bottling and selling the water abroad, but the Utility refused to add more water into the system to compensate for the water being stored and exported, many local residents would go thirsty and maybe even die – probably the poorer ones who lacked money or political clout to get relief.

That's basically what happens when the currency isn't managed appropriately.

A Different Framework

The currency exists to provision the government and fulfill public purpose, but must be managed to also account for broader economic effects. The following are some of the more essential concepts:

  • Taxation simultaneously creates demand for the government’s currency (we need it to pay the tax), while also reduces spending power (less income gets spent buying what businesses make).
  • Government spending creates new currency as it pays for resources and labor, filling the “gap” created by taxation.
  • In this sense, it can be said that taxation creates some unemployment, and government spending restores (or should result in the restoration of) full employment.
  • It would make no sense for a government to create more unemployment via taxation than it intends to restore by buying enough resources from the private sector and paying for all remaining unemployed workers.
  • It also makes no sense that the government allows for or encourages trade and the saving of its currency by trading partners, which not simultaneously ensuring the domestic economy can maintain full employment.
  • Likewise, it makes no sense for the government to allow its currency to be saved domestically, and not ensure that this was factored into the amount it taxes so as to allow the economy to maintain full employment.
  • So we can say that unemployment is a primary indicator that the currency issuer is not doing its job well, and needs some combination of appropriate tax reductions and spending increases.

The Currency and the Job Guarantee: A Perfect Match

It should now be clear why it makes economic sense, not just social and moral sense, for the currency issuer to fund a transition job for anyone who is able and willing to work but is not currently employed in the public or private sector.

By setting a price for “unused labor” and guaranteeing availability of work, the contributions of the government’s currency will rise and fall automatically during economic cycles, the economy will maintain a base of productivity during downturns, and our workers will be able to retain employment and incomes until they find their next job.

It should also be clear that “stimulus” is a misguided concept for a currency-issuing government. Appropriate fiscal policy is what is most needed. While government investments in infrastructure may vary over time, they should be driven not by "stimulus" goals, but by what is in the national interest and the furtherance of increasing national capital and general well being in all realms of life, including the arts and our ecosystems.

If unemployment is persisting, then the government has a responsibility to remove the constraints is has placed on its currency that are giving rise to the problem. Tax policy should be carefully reevaluated with these concepts in mind, but most importantly, we need a job guarantee as the anchor for our economy, our currency, and our society.