Friday, February 7, 2014


This post provides background you'll need for tomorrow's post.

The Full Employment Budget (1)

From an undated (must be early '70s) PDF at Brookings -- The Full Employment Surplus Revisited, by Arthur M. Okun and Nancy H. Teeters. Well said:
In a period of slowdown in economic activity, the movement of the actual surplus or deficit in the federal budget must be carefully interpreted. If a shift to deficit merely reflects a slower growth of federal revenues associated with a weakening of economic activity, that shift is an automatic stabilizer bolstering demand rather than a stimulus propelling the economy.

Economists have long been concerned with the inadequacy of the actual surplus (or deficit) as a measure of fiscal impact. It fails to distinguish the budget's influence on the economy from the economy's influence on the budget. The actual surplus (or deficit) is the composite result of the budget program, as defined in terms of expenditures and tax rates, and the strength of aggregate demand. To remedy the basic defect of the actual surplus as a fiscal indicator, the concept of the full employment surplus was developed. The full employment surplus is an estimate of what the federal surplus would be if the economy were operating along the path of its potential gross national product (GNP). It is thus not affected by fluctuations in economic activity that shrink or swell the revenue base relative to that associated with the path of potential growth. The full employment surplus is thus a way to focus on the policy actions that determine expenditure programs and tax rates, and to separate them from a consideration of the autonomous strength of private demand and of the posture of monetary policy.
The concept was used by several economists analyzing the sluggish economic situation and outlook in 1960 and early 1961 - David Lusher, James Knowles, Herbert Stein, and Charles Schultze. They stressed the large shortfall of federal revenues associated with the shortfall of the economy below high employment, pointing out that fiscal policy was considerably more restrictive than was evident in the actual federal accounts.

Under full-employment budgeting, a policy of the 1960s, with the full-employment budget in balance, if the economy was at less than full employment then the actual budget would be in deficit. It was thought a justifiable deficit, but it was still a deficit.

The Full Employment Budget (2)

At Ingrimayne, under Measuring Fiscal Policy, Robert Schenk writes:
If the government desires to increase total spending in the economy with fiscal policy, it can either increase its spending or reduce taxes (or both). Either policy will increase the government's deficit (or reduce its surplus). Because policies that increase the deficit are expansionary and policies that decrease it are contractionary, it would seem reasonable to use the government's deficit or surplus as a measure of how tight or easy fiscal policy is. However, such a conclusion is wrong.

Suppose government leaves spending and taxing policies unchanged and the economy enters a recession. The lower income levels that the recession causes will cut tax receipts (income and sales taxes account for most tax revenues), and transfers will increase as more people qualify for various welfare programs and unemployment compensation. The government's budget will move into a (larger) deficit even though there has been no change in policy.

Hence, two sorts of factors influence the size of the deficit: changes in policy and changes in the economy. As an indicator of fiscal policy, the deficit suffers from a problem of feedback: the size of the deficit affects the performance of the economy, but the performance of the economy affects the size of the deficit. For a measure of fiscal policy to be a reliable indicator of how government policy is changing, it must be unaffected by changes in the economy.

To construct an acceptable measure of fiscal policy, one must eliminate feedback effects...

Essentially a restatement of the Okun and Teeters excerpt. Hopefully it provides perspective.

The Full Employment Budget, usually associated with Walter Heller

From a paper you can't download, at EconPapers: The Council of Economic Advisors and the "Full Employment Budget Concept": Keyserling before Heller! by W. Robert Brazelton:
This paper deals with the general concept of the Full Employment Budget (FEB) usually associated with Walter W. Heller...
Heller obviously employed budget deficits as a policy tool, then.

Walter Heller saw himself as Keynesian.

From a four-page PDF named 25_28.pdf, an excerpt (pages 25-28) from BIATEC, Volume XIV, 2/2006. An article titled Walter Wolfgang Heller: Economic Theory at Service of Economic Policy

New dimensions of political economy

Walter Heller named his most important publication "New Dimensions of Political Economy" (1966). He wrote in the introduction that these "new dimensions" are largely the consequence of the extensive use of modern economic theory in economic policy. This work came out at a time when the US economy was reaching the peak of a long-lasting period of prosperity, which Heller linked to the culmination of the Keynesian revolution. Economic success raised the prestige of professional economists, many of whom held high government positions and applied Keynesian policy in the form of the "new economics".

...prosperity, which Heller linked to the culmination of the Keynesian revolution.

...Keynesian policy in the form of the "new economics"

The 1960s: Persistent Peacetime Deficits

Rather, the revolution of the 1960s was a revolution in economic ideas. The model that policymakers used to understand the economy changed in dramatic ways. This led them to make radically different policy recommendations.

The resulting policy outcomes had two effects on the economy. One was to generate inflation and short-run instability. The second was to end the historical norm of long-run budget balance. The 1960s introduced Americans to the phenomenon of persistent peacetime deficits.

The 1960s introduced Americans to the phenomenon of persistent peacetime deficits.

A Crude Summary

By design, economic policy in the 1960s used Federal deficits as a policy tool. It seems this was something new at the time. The policymakers who designed deficits into their policies thought of themselves as Keynesian.

1 comment:

Jazzbumpa said...

There's something that troubles me about this, and it has to do with the feedback.

Since I haven't studied Keynes my impression might be naive.

It strikes me that the presence or absence of a deficit, per se, is close to irrelevant. The important factor for expansionary fiscal policy is government spending. Government spends when the private sector can't or won't.

If this causes a deficit, it's because of a resulting imbalance between revenues and expenses, not because the deficit is the goal.

This is also why I think [probably contra Keynes] that a tax cut is not a priori stimulative.

Cutting millionaires taxes does close to nothing for the rest of us, and cutting taxes at the low end is relatively ineffective during a debt overhang situation like now, because the money disappears into debt repayment or under mattresses.