RateWatch #329 – Fiscal Policy
November 9, 2002 By Dick Lepre
dicklepre@rpm-mortgage.com

What's Happening

Treasuries benefited from a technical recovery from an oversold market followed by a larger than expected 50-basis point Fed easing.

Fiscal Policy

So much to comment on this week: the election, a large Fed move, and most importantly, the Winona Ryder trial.

The previous week may be looked back upon, over the next few years, as an important one for our economy. The FOMC lowered the target rate for Fed funds to 1.25%.  This is a number that is so miniscule that it is a bit frightening in as much as it puts the Fed in much the same position as the Bank of Japan.  Once rates get so low there is nothing to lower them to. 

If it is the case that six months go by and business is not spending and the economy is stagnating then the only other course of action that the federal government has is fiscal policy.  When the federal government makes decisions on taxation and spending with a view to influencing the level of production and employment, this is called "fiscal policy." That translates into lowering taxes and/or raising spending in a manner so as to stimulate the economy.  This also means deficits.  Deficit spending is not bad if the result is a boost in economy and future offsetting tax receipts.  Since the government does its accounting on a cash basis the deficit looks worse than it is because it, in effect, does not amortize its assets.

While folks seem to accept the Federal Reserve’s decisions there will be a lot of arguing about fiscal policy because it is politicians who are making the decisions and doing the talking.  If taxes are cut, someone will be unhappy.  If money is spent on X and Y someone will be unhappy that it is not spent on Z.

This is why this week’s election outcome was important.  It gave the administration a relatively compliant Congress and a public which should be willing to go along with deficit spending.

Bush seems to have an almost unreal amount of support.  To some extent, it is his personality.  Americans see him as a “regular” guy.  He does not come off as a sophisticated politician and, in his case, this serves him well.  He also seems to have drawn on a reservoir of post 9/11 sympathy.  That sympathy seems analogous to what Reagan had after he was shot.  Bush’s single-mindedness is likely to serve him well in selling fiscal policy. 

An underlying question is this:  to what extent does it really make a difference to the economy how wisely the money is spent?  There is a duality of purpose here.  Spending the money and cutting taxes will stimulate the economy.  Should the tax cuts be geared toward encouraging investment? Or should there merely be an additional income tax cut, effectively giving consumers more money to spend and letting consumer spending continue to be the stimulus of the economy?  Hopefully, somehow, someway wisdom (or luck) can prevail and there can be residual benefit if the money is spent wisely.  The important thing from the point of view of the economy is that the money is spent.  Money is spent on lots of things that may not really be necessary: video games, women’s shoes, beer, diamonds, Wonderbras, cigars, and perfume, for example.  The economy does not need to justify the value of any of these expenses.  It gains an immediate benefit.  Exceptions may exist for things such as tobacco and alcohol that lave residual expenses but, heck, without them doctor’s incomes would fall.