POL 313

 

The Presidency

The President and Economic Policy

 

 

 

 

Will Rogers:
"Anyone who thinks they can understand the economy
is either a fool or an economist".

One of the "supra-constitutional roles" of the President is "manager of the economy"

In many respects, presidents' administrations rise and fall on public perceptions of the current state of the economy. Jimmy Carter in 1980 (-), George Bush in 1992 (-) and Ronald Reagan in 1984 (+), Bill Clinton in 1996 (+) are examples of presidents whose fortune rose or fell on public perceptions of the president's ability to "manage the economy".

While presidents generally have a lot of latitude in national security policy,
they generally do not have the ability to "manage economic policy".
Most suggest that, at best, they can nudge economic policy!

Before describing the relationship between the president and economic policy, some definitions:

 

Macroeconomic policy

We need to distinguish between actions designed to manage the entire economy (macroeconomic policy) and actions designed to control specific aspects of the economy (microeconomic policy).

Macroeconomic policy is normally attempted via two principle tools:

1) fiscal policy

2) monetary policy

Fiscal policy refers to the government's efforts to regulate the level of the nation's economic activity by varying taxes and public expenditures. In general, fiscal policy seeks to expand the economy by increasing spending and reducing taxes or to contract it by decreasing spending and increasing taxes.

Budget deficits are generally considered expansionary while a budget surplus is deflationary.

The president and Congress jointly make fiscal policy.

They determine expenditures through budgeting and appropriations and they establish taxes and tax rates through legislation.

Monetary policy refers to a government's efforts to regulate the economy by controlling the money supply. Done by a government's central bank
(in US it is the Federal Reserve System).

Monetary policy is made by the 7 member Board of Governors of the Federal Reserve System, headed by a chairman who is currently Ben Bernanke.

The goals of macroeconomic policy have remained constant since the Depression:

1) hold down the rate of inflation

2) to establish and maintain "full" employment

3) to achieve a steady rate of economic growth

 

In the pursuit of these goals, four different theoretical perspectives have emerged:


conservative economic theory

it essentially argues that balanced budgets,which create confidence
in the economy, should be the key to government's economic decisions.
This approach lost credibility during the Depression.

 

Keynesianism

emphasizes economic stimulus and deficit spending

Keynes argued that the cause of economic decline was a drop in the private demand for goods and services. Government should stimulate demand by increasing its expenditures or by reducing taxes. The temporary deficits would be financed by government borrowing and repaid during periods of hyperactivity of the economy. (Didn't necessarily remain temporary and has an "inflationary bias" since politicians would rather increase spending and cut taxes than vice versa)

Monetarism


Led by Milton Friedman, monetarism holds that the key to maintaining economic stability lies in limiting the growth of the money supply to no more than the actual growth rate of the economy. Inflation occurs when the money supply expands to rapidly. To remedy inflation, contract the money supply.

This approach is less painful "politically" than the Keynesian notion of cutting spending and increasing taxes because contracting the money supply would be done by the "non-elected" Federal Reserve Board ("the Fed"). During the 1970s this approach became politically unattractive and a new approach emerged:

Supply-side economics


This is really a combination of Keynesianism and monetarism. The emphasis is on strict monetary restraint to control inflation and the use of fiscal policy (tax cutting) to encourage investments and productivity which in turn, it is argued, increase the supply of goods and services. Increasing the supply increases the demand. Supply-siders didn't worry about the deficits created from the tax cuts, arguing that additional savings and economic activity would generate enough revenues to balance the budget. (So much for the theory. During the 80s deficits exploded and revenues did not rise!). Here is an interesting analysis.
For more on economic theory, click here

Microeconomic Policy

Refers to government regulation of specific economic activities and also includes anti-trust policy. The focus and outcomes normally impact only a select segment of the economy. Presidents have thus not expended a great deal of energy in this area. When they have become active in this area it is generally to attempt to achieve some macroeconomic purpose. For example, Reagan emphasized deregulation and privatization as a means to reducing the role of government and strengthening the free market.

 

Historically (pre-FDR), presidents spent more time on microeconomic policy than macroeconomic policy. The emphasis was on allowing the free market to operate and intervening only to "correct" imperfect markets, especially to expand competition. Presidents were thus involved in trying to insure competition. The Sherman Anti-Trust Act of 1890 was a major tool to "bust trusts" and encourage competition in economic arenas. Wilson persuaded Congress to establish the Federal Trade Commission, an independent regulatory commission with authority to regulate anticompetitive and unfair business practices.


The Depression gave FDR the opportunity to expand government intervention into microeconomic policy (and thus macroeconomic policy) in a number of areas. During the 60s and into the 70s government became more involved in a number of microeconomic regulatory activities (cleaner air and water, safer automobiles and consumer products, etc.).


Deregulation began in the 1970s


Presidents and the Economy

The era of modern macroeconomic policy and the president's role as manager of the economy have their roots in the New Deal programs of FDR. Probably the most significant aspect of the New Deal programs was the commitment to Keynesian economics and the belief in using increased government spending to compensate for inadequate private investment and consumption.

While many argue about whether it was the programs or the mobilization of resources to fight World War II, the government's commitment to Keynesian economics continued after the War. In 1946 the Employment Act committed the government to maintaining "maximum employment, production, and purchasing power". This act translated into law a public expectation that government would now be a "manager of the economy" --and it had better be a prosperous one! Presidents assumed this responsibility.

The history of the American economy since World War II is one of economic expansions and periodic recessions. From 1947-1966, the period of growth following the War, relatively non-severe recessions occurred in 1954 and 1958. In 1964, an income tax cut had the desired effect of expanding the economy and increasing revenues. People began to assume that "scientific notions" like economic forecasting could be developed to the point where "fine-tuning" of the economy would be all that was necessary.

The Vietnam War and the initial reluctance to raise taxes to support it, led to a dramatic increase in inflation. Since 1966, the economy has been far more volatile than the pre-1966 years. Underlying these developments have been systemic factors beyond the easy control of government:
1) increased dependence on foreign oil;
2) growing interdependence with other industrialized countries;
3) the decline in US productivity and the increase in other countries;
4) the growth and maturation of social welfare entitlement programs; and
5) commitment to improving environmental quality
Nixon was really the first president to begin to address these problems. His attack was twofold: 1) try to reduce federal spending and 2) wage and price controls (allowable under the Economic Stabilization Act of 1971). These lasted until 1973 and were relatively unpopular. When Ford became President, the major effort was on inflation (WIN) and his lack of success was partially responsible for his loss to Carter in 1976. Carter's most important economic decision was naming Paul Volcker chairman of the Fed. Volcker was a monetarist who believed that the way to cure inflation was by restraining the growth of the money supply. Interest rates rose sharply and inflation did not subside quickly---part of the reason for Carter's defeat in 1980.

Part of Reagan's campaign pledges involved "reaganomics"-major reductions in taxing and spending. In 1981 Congress passed the largest tax cut in US history. Infaltion was reduced (some claim it was Volcker's actions) and economic growth occurred. The problem---deficits. Deficits grew because revenues declined because of both the tax cuts and the recession from 1981-1982 and defense spending increased. With the new tax cuts politically untouchable, this became the basis for a "structural" deficit problem--the total federal deficit increased from 990 billion in 1980 to 3.1 trillion in 1990 with net interest payments becoming the fastest growing item in the deficit. In 191 interest on the debt was 214.3 billion. The slowing of the economy and Bush's renege on his "no new taxes pledge" led to his defeat in 1992. Where are we today? Relatively low inflation, deficit reduction, low unemployment. Why?


Your answer will in part be political. As can be done throughout the history of the modern economy, you can either take credit or pass the blame for the myriad complex factors which affect the economy. Is it tax cuts, frugality, stimulus, monetarist policy, or the cyclical nature of the American economy?

A political scientist writing on presidents and economic performance argued that there are three major obstacles for presidents to overcome:

1) unrealistic expectations about the economy
2) the president's limited authority; and
3) limited knowledge and unreliable data


The Politics of Macroeconomic Policy

There are four considerations in understanding presidents actions
in the economic policy area:

1) party politics--
including philosophical commitments to the role of government, social spending

2) electoral politics--
presidents are often willing to sacrifice the long-term for short-term
(pre-reelection success);

3) interest group politics--
business, labor, the financial community;

4) bureaucratic politics---
a) the Council of Economic Advisors
b) OMB
c) the Treasury Dept;
d) the Federal Reserve Board