Ed Dolan's Econ Blog

Marco Rubio Would Leave Economic Policy Rudderless

Stabilizing the national economy is one of the federal government’s key responsibilities. Is that too much to ask? OK, then, can we at least ask that the government not make things worse when instability strikes?

Not if you’re Marco Rubio. Sooner or later an oil price meltdown, a banking crisis, or a Chinese hard landing is going to threaten our economy with a new recession. If a President Rubio were to have his way, the federal government would be legally bound to allow the economy to drift rudderless onto the rocks.

I’m not making this up. I’m just going by Rubio’s own words. (And, yes, his views are widely shared within the Republican Party. I’m singling him out mainly because he expresses them so clearly.)

Let me explain the Rubio/GOP view of economic stabilization. If you remember your basic college econ course, you’ll know that the first line of defense against a recession is fiscal policy. When the economy goes into a slump, spending rises on unemployment compensation, food stamps, and other benefits. At the same time, tax receipts, which are linked to income, decrease. Because the spending increase plus the tax decrease automatically cushion the slump, economists call them automatic stabilizers.

If you’re a true Keynesian, automatic stabilizers aren’t enough. You add some discretionary fiscal stimulus in the form of road projects and maybe a temporary tax rebate. If the timing is right, that softens the recession even more and speeds the recovery.

The GOP has never been enthusiastic about Keynesian stimulus, but at least, in the past, Republican presidents and lawmakers had enough sense to allow automatic stabilizers to operate. Not Marco Rubio. He is an enthusiastic backer of a balanced budget amendment. Several forms of such an amendment are floating around, all of which call for federal spending and taxes to be in balance, not just on average, but every single year.

It sounds like a sensible idea, until you think about it. But then, you see that the idea of balancing the federal budget every year is nuts. It would mean that when the economy went into a slump, pulling tax revenues down, Congress would have to enact across the board emergency spending cuts to keep a deficit from emerging. The cuts would quickly hit jobs and household budgets. Consumer spending would fall, firms would cut output to fight ballooning inventories. Without the automatic stabilizers, a mild recession would turn into a tailspin.

As if cutting spending during a recession weren’t nutty enough, think what a balanced budget amendment would do during a boom. When the economy expands, tax revenue rises and those automatic stabilizers push the budget into surplus. With the balanced budget constraint temporarily off their backs , Congress would have a field day. Every lobbyist in town would get a grab bag of goodies—government contracts, subsidies, new tax loopholes or whatever—that would eat up the surplus before it formed. When the next recession came along, the government would have to slam on the brakes even harder to keep within the confines of the balanced budget law. (For a more detailed critique of balanced budget amendments, see this earlier post.)

A balanced budget amendment would make the conduct of economic policy far more difficult, but things wouldn’t quite be hopeless if we could count on the Fed to come to the rescue. Under current law, the Fed has two obligations: To prevent inflation and to maintain full employment. Economists call this the Fed’s dual mandate. During a boom, it means the Fed raises interest rates to cool inflation. In a slump, it cuts rates to stimulate employment. If rates go all the way to zero, the Fed can use extraordinary measures like “quantitative easing” to provide even more stimulus.

The Fed alone can’t fully stabilize the economy. Countercyclical monetary policy just isn’t powerful enough. But it helps. Economists are widely agreed that if the Fed had sat on its hands, the Great Recession would have would have become Great Depression II.

But candidate Rubio wants no part of monetary activism. Here is what he said about the Fed in this week’s South Carolina town hall:

That’s not the Fed’s job to stimulate the economy. The Fed is a central bank, it is not some sort of overlord of the economy. They’re not some sort of special Jedi Counsel that can decide the best things for us.

The Fed is a central bank. Their job is provide stable currency and I believe they should operate on a rules based system. They would have a very simple rule that determines when interest rates go up and when interests rates go down.

So just what is this “simple rule” Rubio is talking about? He provides the details elsewhere. His rule would replace the Fed’s dual mandate with a single mandate to prevent inflation. The Fed would be required to raise rates to stop inflation during a boom, but it would be barred from doing anything when unemployment soars during a recession.

Put the balanced budget for fiscal policy together with an anti-inflation single mandate for the Fed, and you get a national economic policy that is truly perverse. Remember that old war-on-drugs ad that pictures a farm-fresh egg (“This is your brain”) and a fried egg (“This is your brain on drugs”)? Here is my version—our next recession, and our next recession under the GOP:






13 Responses to “Marco Rubio Would Leave Economic Policy Rudderless”

Patrick R. SullivanMarch 1st, 2016 at 9:26 am

'If you remember your basic college econ course, you’ll know that the first line of defense against a recession is fiscal policy. '

You really believe that? How do you explain the failure of fiscal policy–deficits on the order of 10% of GDP–to successfully fight the Great Recession?

Or the 50% (real) increase in Federal spending under Hoover to prevent the Great Contraction? Which was the opposite result from the 1920-21 recession which was fought with spending restraint. You've heard of the Roaring Twenties?

In fact, until 2009 the overwhelming majority of the economics profession believed that fiscal policy was impotent in a recession. That monetary policy was the key. Maybe Rubio has read the trasncript of that famous 1968 NYU debate between Walter Heller and Milton Friedman, entitled; 'Monetary vs Fiscal Policy: A Dialogue.'

A debate Friedman won hands down.

Ed Dolan EdDolanMarch 1st, 2016 at 10:15 am

(1) You ask, "How do you explain the failure of fiscal policy–deficits on the order of 10% of GDP–to successfully fight the Great Recession?"

Good question, two-part answer.

(1a) There is considerable evidence that the Obama stimulus did work in the sense that it made the Great Recession less severe than it otherwise would have been. True, not all economists agree with this conclusion, but it is my best conclusion regarding the preponderance of evidence, after reading studies on both sides of the issue. For a quick survey of research on the topic, see this item, which includes links to the full studies under discussion:

(1b) The second part of the answer is that although fiscal stimulus was applied early in the recession, during the recovery, US fiscal policy was systematically procyclical, as shown by the fact that the primary structural balance of the federal budget began moving steadily toward surplus after 2010. So yes, fiscal policy WAS effective, that is effective in SLOWING the recovery. See here for some charts:

(2) You say, "In fact, until 2009 the overwhelming majority of the economics profession believed that fiscal policy was impotent in a recession. That monetary policy was the key."

Unfortunately, Friedman himself is not around to give us his evaluation of fiscal vs. monetary policy during the Great Recession. (Personally, I think he would have been disappointed with the modest effects of QE, a policy he earlier advocated for Japan.) However, you certainly exaggerate the extent to which economists today think that monetary policy alone can do the job. This quote from Ben Bernanke (who knows a little about the Great Depression, about economics, and about monetary policy) is typical of what I see as the current mainstream view:

"To this list of reasons for the slow recovery–the effects of the financial crisis, problems in the housing and mortgage markets, weaker-than-expected productivity growth, and events in Europe and elsewhere–I would add one more significant factor–namely, fiscal policy. Federal fiscal policy was expansionary in 2009 and 2010. Since that time, however, federal fiscal policy has turned quite restrictive; according to the Congressional Budget Office, tax increases and spending cuts likely lowered output growth in 2013 by as much as 1-1/2 percentage points. In addition, throughout much of the recovery, state and local government budgets have been highly contractionary, reflecting their adjustment to sharply declining tax revenues."

Patrick R. SullivanMarch 1st, 2016 at 6:34 pm

Well, that's not really what Friedman advocated for Japan, as he told David Laidler in 2000:

David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?

Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”

It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.

But, I'd think that 2013's evidence is the death knell for 'fiscal stimulus' as the answer. GDP growth was higher in 2013 than in 2012. Paul Krugman even predicted that the tighter fiscal policy–higher income tax and payroll tax rates, along with the sequester–in 2013 would be a natural experiment.

An experiment Krugman was pretty quiet about after it took place.

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