Fiscal responsibility

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There is an important point that needs to be stressed to those who regard themselves as fiscal conservatives. By concentrating on the wrong thing, the deficit, instead of the right thing, total government spending, fiscal conservatives have been the unwitting handmaidens of the big spenders.
Milton Friedman[1]

Fiscal responsibility refers to governments campaigning on smaller deficits, balanced budgets or budget surpluses. Although necessary to some extent in order to achieve growth and development[2][3] it can be economically counterproductive to do so during economic crisis (except when the crisis are caused by the fiscal irresponsibility itself), or to cut spending in all areas, since some, like education and poverty alleviation usually have desirable externalities and outcomes. Advocates of fiscal responsibility propose policy change with the goal of achieving a lower deficit or larger surplus. Overall, the right advocates to achive fiscal responsibility by cutting spending, but it can also done by increasing taxes, an idea more popular with the left.[4]

Austerity instills a fear in people, beginning with the idea advanced by Adam Smith that the government budget is equivalent to a household budget and snowballing from there (debt ceilings, big government, "living within your means" etc.). Although that’s true to a certain point, government is more than a household, and as we’ll see it doesn't need to pursue fiscal responsibility all the times. Detractors sometimes call it deficit fetishism[5] or austerianism[6] – after wingnut pseudo-theories supported by Austrian economists. Even though except some really nutty Austrians economists are known for their exaggerated fiscal hawkish, support for fiscal responsibility exist in most of the mainstream economics schools to some extent.

Views of economists[edit]

A common inside joke among economists is that “today’s debt is tomorrow’s taxation", as the debt will have to be paid anyway (and probably not by the meager economic growth that it usually causes).

Most economists agree that a large federal budget deficit has an adverse effect on the economy (83%) and that the gap between Social Security funds and expenditures will become unsustainably large within the next fifty years if current policies remain unchanged (85%). 90% agree however that fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy, so fiscal responsibility can be ignored to a certain point during some economic crisis.[7] However in normal conditions, 80% of the economists agree that sustained tax and spending policies that boost consumption in ways that reduce the saving rate are likely to lower long-run living standards.[8]

Government spending and deficits are not robustly correlated with economic growth when evaluated individually[9]. On the other hand, per capita growth and the ratio of private investment to GDP are negatively related to the ratio of government consumption expenditure to GDP.[10] There is, however, evidence that it in fact slumps growth.[11] In other words, a government that spends too much won’t cause growth, but actually slumps it, and this is even worse if the country spends too much and has a big deficit. As a result, the population pays twice: by higher taxes and slower economic growth.

One of the reasons is because a larger fiscal deficit negatively impacts on the national savings – one of the most important factors of growth. That happens because when the government borrows money to finance the deficit, it reduces the supply of loanable funds available to finance investment by households and firms, crowding out money that households and companies could invest. Fiscal deterioration is also tied with higher interest rates, as people expect to earn more by lending money to the government since the perception of risks are higher and the deficit is too high. This is specially truth to third world countries, but rich countries like US, Germany and Italy are also affected by this.[12] Nobel Prize winner Robert Lucas argued that, since people based their expectations not only in the past, but also in the future, and take into account the inevitable adjusts that the government will have to make. As a result, an active fiscal policy is useless.[13]

Some fringe economic schools, like Post-Keynesian economics, and in particular Modern Monetary Theory, argue forcefully against notion of fiscal responsibility that is used to motivate austerity programmes, arguing that sovereign governments are not analogous to households, and the economically "right" level of government deficit or surplus entirely depends on the state of the economy at the time (e.g. the level of unemployment). These points have been widely rejected by basically every mainstream economists nonetheless.[14]

Summarizing, fiscal responsibility shouldn't be pursued all the times, nor it should be pursued "by any means". But should, at least to some extent, be the rule, not the exception. The fiscal and monetary policy should be less active when the economy is growing, but it can prevent a larger downfall during crisis, where fiscal responsibility should be put to sleep (unless, like in the Greek case, the fiscal deterioration is the cause of the crisis), and when this moment comes, countries that had been responsible can also provide a better response.

Political support[edit]

The principle of fiscal responsibility, together with "sound money", is endorsed by many right-wing parties from various different countries, although it's quite unusual for a country to run on a fiscal surplusWikipedia.

Left-wing parties sometimes also endorse it. This might happen for two reasons. One of the is to attain credibility with floating voters, rather than because they actually believe in it. For example, in the UK, Gordon Brown pledged prior to the 1997 general election to follow Conservative spending plans for the first 3 years of a Labour government, and kept his promise, after which he was free to increase spending as he had wanted to all along. Ed Miliband tried the same electoral strategy, but his opponent David Cameron defeated him — in part by using the cunning gambit of promising to spend more than Miliband on the revered National Health Service. Clearly, Ed hadn't quite understood how the Brown principle worked - you don't go more Tory than the Tories on spending. Another reason is when the real world imposes by necessity fiscal responsibility, like the Swedish Social Democrat Party knows very well.[15] Another example is the former French president François MitterrandWikipedia, who, despite being a lifelong socialist, made a "tournant de la rigueur" and was forced to adopt more rigid fiscal and monetary policy during his presidency after two years of massive failure. Other left-wing leaders that had the same fate are the Italian former Prime Minister Massimo d'AlemaWikipedia and the Spanish former Prime Minister Felipe GonzálezWikipedia.

To a lesser or greater degree, depending on the individual member country and its level of influence within the EU, the European Union has advocated fiscal responsibility[16]. Greece, the most indebted country in the Euro zone ran for huge deficits for years, and as a result was engulfed by a severe economic crisis. From 2016 to to 2019, the hellenic country finally managed to control its deficit and started to run of a budget surplus[17] and, around the same time, the economy started to grow again.[18]

The Tea Party movement has long pushed for a radical fiscal responsibility agenda[19]. Quite how they intend to combine this with tax cuts is left unexplained. This culminated in the Congressional Tea Party Caucus, which advocates for budget surpluses.[20]

See also[edit]

References[edit]

  1. "The Kemp-Roth Free Lunch", Newsweek 8.7.78.
  2. https://www.imf.org/external/pubs/ft/wp/wp9801.pdf
  3. https://ieg.worldbankgroup.org/sites/default/files/Data/reports/eb9_web.pdf
  4. of fiscal responsibility
  5. Is deficit fetishism innate or contextual?
  6. of the Week: Austerianism
  7. Source: Richard M. Alston, J. R. Kearl, and Michael B. Vaughn, “Is There Consensus among Economists in the 1990s?” American Economic Review (May 1992): 203–209; Dan Fuller and Doris Geide-Stevenson, “Consensus among Economists Revisited,” Journal of Economics Education (Fall 2003): 369–387; Robert Whaples, “Do Economists Agree on Anything? Yes!” Economists’ Voice (November 2006): 1–6; Robert Whaples, “The Policy Views of American Economic Association Members: The Results of a New Survey,” Econ Journal Watch (September 2009): 337–348. ‘’’apud’’’ Citation: Mankiw NG. Principles of Economics, 9th edition. South-Western Cengage Learning; 2021.
  8. https://www.igmchicago.org/surveys/fiscal-policy-and-savings/
  9. Fiscal Policy and Growth
  10. Economic Growth in a Cross Section of Countries
  11. Fiscal Policy and Economic Growth
  12. Public debt and long-term interest rates: the case of Germany, Italy and the USA
  13. https://www.sciencedirect.com/science/article/abs/pii/0022053172901421
  14. https://www.businessinsider.com/economist-survey-alexandria-ocasio-cortez-modern-monetary-theory-2019-3
  15. An account of fiscal and monetary policy in the 1990s
  16. Stability and Growth Pact
  17. https://www.statista.com/statistics/270398/budget-balance-in-greece/
  18. https://fred.stlouisfed.org/series/CLVMNACSCAB1GQEL
  19. http://blogs.wsj.com/washwire/2010/02/05/tea-party-leader-launches-political-outfit/
  20. Party Caucus Mission and Statement of Principles (archived from 2014)