For election, listen to what candidates say about fiscal policy
On the Money
From the August 6, 2004 print edition
With the Democratic national convention commencing this week, we move into that period of time occurring every four years where political slogans and sound bites rain down– creating the proverbial great flood of ancient times. Insistent campaign promises, ranging from thoughtful to ridiculous will saturate our eyes and ears over the next several months.
While much of the political process is the zealous gathering of support through emotional appeal, there is some quantitative basis underneath these rallying battle cries.
Here’s a summary look at the theoretical relationships between government and money.
The government has two major tools for achieving economic health: fiscal policy, through which it determines the appropriate level of taxes and spending; and monetary policy, through which it manages the supply of money.
Since the Depression, the federal government has tried to create a combination of fiscal and monetary policies that will allow sustained growth and stable prices (no inflation).
The primary tools of fiscal policy are spending and taxation. The deliberate manipulation of government purchases, including military (funding a war, for example), public works projects, scientific research are designed to achieve a balance between full employment, price stability (restrain inflation), and economic growth.
The government has income from only one primary source-taxes. Therefore manipulating tax rates, rules and structures, tax incentives for certain activities (such as investment in long-term assets) are designed to control both the income level of the government and individual disposable income.
The development of fiscal policy is an elaborate process. Each year, the president proposes a budget, or spending plan, to Congress. This is why budget issues are central to a candidate’s success. It will be the successful presidential candidate who initiates the government spending process. Virtually every campaign initiative will have an effect on the budget.
Taxation policy affects us more directly. The overall level of taxation is decided through budget negotiations. Although the government ran up deficits, (spending more than it collected in taxes) during the 1970s, ’80s, and the part of the ’90s, the populous generally believe budgets should be balanced.
Historically, most Democrats are willing to tolerate a higher level of taxes to support a more active government, while Republicans generally favor lower taxes and smaller government.
If you keep all this in mind, it will help you to better evaluate campaign promises and proposals.
Although not nearly as emotionally evocative, monetary policy is also central to the government’s role in the economic life of the nation. The job of managing the overall economy shifted substantially from fiscal policy to monetary policy during the later years of the 20th century.
The Federal Reserve uses three main devices for maintaining control over the supply of money and credit in the economy: open market operations, the reserve level required by banks, and the discount (interest) rate.
Although not as obvious as interest rates, the most important is open market operations, or the buying and selling of government securities. To increase the supply of money, the Federal Reserve buys government securities from banks, other businesses, or individuals, paying for them with a check or a new source of money that it prints.
Reserve limits for deposit-taking institutions specify how much money is set aside; either as currency in their vaults or as deposits at their regional Reserve Bank. Raising reserve requirements forces banks to withhold a larger portion of their funds, thereby reducing the money supply.
The discount rate or interest rate that commercial banks pay to borrow funds from Reserve Banks is by far the most visible tool used in monetary policy. It is the driver that ultimately sets the amount of interest that business and individuals will have to pay when borrowing money. By raising or lowering the discount rate, the Fed can promote or discourage borrowing and thus alter the amount of revenue available to banks for making loans.
Mixing these elements together isn’t easy. Additionally, while a strong economy may be a prerequisite to social progress, it may not be the ultimate goal. The traditions of public education, environmental regulations, rules prohibiting discrimination, and government programs like Social Security and Medicare, to name just a few – are also central to American values.
The late U.S. Senator Robert Kennedy explained in 1968, economic matters are important, but gross national product “does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile.”
© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.