Why I Oppose "Fiscal Policy"

...to implement a target growth path for nominal GDP (or to target inflation or to manipulate the output gap.)

The problem is that fiscal policy involves changes in taxes and government spending.   Politicians (and many economists) have strong views about the proper level and composition of government spending as well as the proper level and composition of taxes.

Given the quantity of base money or some target for interest rates, it is very likely that lower taxes with unchanged government spending will result in more spending on output.   The demands for various private goods services will be higher than otherwise.

It is almost certain that with given taxes an increase in government spending will result in more spending on output--mostly limited to what the government itself purchases.

It is probably true that nearly all politicians have some taxes they would like to see cut and some government spending they would like to see increased.   But there are also many politicians who are dead set against cutting some taxes.   And there are politicians who are very much opposed to raising some types of government spending.   In fact, there are politicians committed to raising some taxes and cutting some types of government spending.

For example, a typical conservative Republican might favor cutting the relatively high marginal tax rates facing those with high incomes.  He might favor increases in defense spending.   At the same time, he might favor cutting various sorts of social programs that purportedly help the poor and working class (well, that's what the Democrats say these programs do.)   He might even accept the need to limit the growth of entitlement spending that benefits his own middle class constituents!  In general, this conservative Republican doesn't want to see the burden of the Federal government grow, and maybe would like to see it shrink, at least relative to total size of the economy.

Meanwhile, the typical liberal Democrat might favor tax cuts targeted at the poor and middle class, but she is very much opposed to cutting taxes on higher income groups.  On the contrary, her long term goal is to raise those tax rates.   Shifting the tax burden toward the rich  and away from the poor to equalize after tax income is a long term priority.   Similarly, raising defense spending (unless it happens to be in her own district) is not a priority, because shifting the composition of spending towards programs that benefit the poor and middle class is a long term goal.   (The Democrat activists who earn their incomes running the programs certainly claim they are helping the poor and working people.)  In principle, this liberal Democrat would applaud an expansion in the size and scope of the Federal government to help provide for urgent social needs and  solve severe social problems.

"Fiscal policy" can probably impact spending on output but proposals to cut taxes and raise government spending are going to shift tax shares, the composition of government spending, and the overall size and scope of the Federal government.   These are highly controversial questions.  

If one imagines that one faction has absolute political dominance, then it can cut the taxes it likes least and raise the spending it likes most.    By focusing more on tax reductions or increases in government spending, it can move towards its preferred size and scope of government.

But with separation of powers and divided government, why should we expect that these other concerns will not overwhelm any interest in maintaining the level of spending on output, keeping inflation on target, or closing output gaps?

When liberal Democrats insist that we should cut the taxes that they always would like to see cut and spend on the government programs that they aways want to fund, saying that in addition to all of their usual reasons for these policies they are needed now to increase total spending, aggregate real output, and employment,  why shouldn't we expect that their political opponents not only will respond with the arguments that they usually use against these policies, but to also add claims that these policies really won't improved economic conditions?  Isn't it the opposition's obligation to refute these arguments?

More importantly, if the conservative Republican opponents control the House and can filibuster in the Senate, why wouldn't they block the proposals?   Maybe they reasonably believe that whatever impact these policies might have on total spending on output are less important than their other adverse effects.  

Similarly, when conservative Republicans propose permanent cuts in marginal tax rates and increased defense spending, why wouldn't we expect that these efforts would be blocked in the Democrat-controlled Senate or face a Presidential veto?    Maybe whatever gains are generated in solving the aggregate spending problem (or closing the output gap) are just less important than long run efforts to shift the burden of taxation and the composition of government spending.  

In my view, economists who see themselves close to the halls of power--whether truly as advisers in government or merely pundits, adopt the mentality of the politicians.   They are all in favor of fiscal policy to solve a shortfall in spending, as long as the fiscal policies are ones that they would support anyway.   Many appear quite willing to trot out doubtful arguments, expecting the opposition to refute them.   (That monetary policy is out of ammunition so we must cut the taxes my "Team" has always wanted cut and increase the spending that my "Team" always wants to fund, is the most frustrating and heartbreaking to me.)

As for those economists way up in the ivory Tower, they simply abstract away from these real world complications.  Should we use fiscal policy to help close an output gap?   Sure, all the best models suggest it will help with the policy rate at zero.  (And let me get back to working some equations.)

If they have little concern with short run stabilization policies, perhaps focusing on research programs that cast doubt on the effectiveness of such measures, whatever preferences they have about tax shares, the composition of government spending, or the proper size of government, may well shine through.    Should we lower taxes?  Sure, lower marginal tax rates improve the efficient allocation of resources.   Should we cut government spending?  Sure, most government spending is wasteful rent seeking.   Should we raise defense spending?  Sure, I am worried that Iran will use nuclear weapons on Israel.  But why should we give the off-the-cuff opinions of some ivory-tower macroeconomist much credence?

Most troubling, what happens when those responsible for setting the "given" quantity of base money or target interest rate are partisans?   "We shouldn't lower our target for our policy interest rate, instead Congress should implement a low, flat income tax."    "We shouldn't expand base money too much, instead, Congress should fund a high speed rail network."

In my view, a monetary regime should not require "cooperation" with the fiscal "authority." Creating "givens" for base money or targets for interest rates and then suggesting that the fiscal authority adjust taxes and spending to keep nominal spending (or the output gap and inflation) at the proper level is a mistake.

In my view, the monetary authority should have a single focus--keeping nominal GDP on a stable growth path and it needs the ability to do so regardless of fiscal policy.   Whatever fiscal policy the politicians develop, it should occur in the context of slow, steady growth of nominal GDP.