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The continuing resolution fiscal alchemy in action

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Ed Dolan
Ed Dolan

A set of slides discussing the recent continuing budget resolution passed by the US Congress, as an illustration of the way in which fiscal policy resembles alchemy, in contrast to the more scientific approach of monetary policy.

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Free Slides from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ The Continuing Resolution: Fiscal Alchemy in Action? Post prepared October 5 , 2010 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.
Congress Passes a Continuing Resolution Fiscal year 2011 —the new budget year for the U.S. government—began on October 1, 2010 On Sept. 29, Congress passed a continuing resolution that will allow the government to continue normal operations until December 3, 2010 Why is the continuing resolution a symptom of what a critic has called “fiscal alchemy?” Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ US Congress Appropriations Committee in Session, March 2008 Photo source: http://commons.wikimedia.org/wiki/File:FEMA_-_34403_-_FEMA_Administrator_at_Appropriations_Committee_Hearing_in_District_of_Columbia.jpg
What is a Continuing Resolution? The Budget Process in Theory January: Congress receives President’s budget message Spring: House and Senate pass a resolution with overall budget goals No later than Oct 1: House and Senate pass 12 appropriations bills that are legally required to allow most government agencies to spend money Note: Entitlement programs like Social Security and Medicaid are not subject to annual appropriations Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ The Budget Process in Practice Political deadlock often prevents passage of appropriation bills by the Oct. 1 deadline Options if the appropriations bills are not passed on time: Pass a continuing resolution that lets each department temporarily continue to spend at the same rate as last year Shut down nonessential government functions until a bill is passed (longest shutdown occurred in 1995)
Alchemy as the Precursor of Science In medieval times, many scholars investigated the natural world through the protoscience known as alchemy. The goals of alchemy included changing lead into gold and finding an “elixir of life” that would cure all diseases Alchemists never made gold from lead, but by intuition trial and error, they learned some useful things, like better methods of distillation Later, alchemy was displaced by modern scientific method based on theory, controlled experiments and testing of hypotheses The Alchemist, by William Fettes Douglas. Photo source: http://commons.wikimedia.org/wiki/File:William_Fettes_Douglas_-_The_Alchemist.jpg Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Monetary Science vs. Fiscal Alchemy* In a recent paper*, Eric Leeper has contrasted the science of monetary policy with what he calls fiscal alchemy “ Monetary policy decisions tend to be based on systematic analysis of alternative policy choices and their associated macroeconomic impacts: this is science. Fiscal policy choices, in contrast, spring from unsystematic speculation, grounded more in politics than economics: this is alchemy.” — Eric M. Leeper, Indiana University * “Monetary Science vs. Fiscal Alchemy,” Federal Reserve Jackson Hole Symposium, 2010 http://www.kansascityfed.org/publicat/sympos/2010/2010-08-16-leeper-paper.pdf Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Picture source: http://commons.wikimedia.org/wiki/File:Alembic.png
Evidence of Fiscal Alchemy: Continuing Resolutions Continuing resolutions are a prime example of unscientific fiscal policy Very short horizon provides no framework for long-term expectations No attempt to optimize policy Continuing resolutions have become the norm, rather than the exception The budget was passed on time, without need for continuing resolutions, in only 3 of the 33 years covered in the chart Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Evidence of Fiscal Alchemy: Budget Projections The nonpartisan Congressional Budget Office has the duty of publishing a range of projections of the federal debt The lower limit, called the baseline scenario, shows what would happen with no policy changes The upper limit, or alternative scenario, shows what would happen if Congress makes changes similar to those made in the past Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Source:: Leeper, 2010, Figure 8
Evidence of Fiscal Alchemy: Budget Projections Everyone knows the upper limit will not happen because it projects impossible levels of debt No one expects the lower limit to happen either because it omits changes that Congress is almost certain to make The range of estimates is very wide and getting wider, further contributing to the great uncertainty about future fiscal policy Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Source:: Leeper, 2010, Figure 8
Contrast: Monetary Policy Aims for Stable Expectations In contrast to the short-term focus and great uncertainty about fiscal policy, the Fed and central banks of other developed countries attempt to provide a clearly-stated framework for monetary policy expectations Although monetary policy is not perfect and there are debates within and outside the Fed, everyone agrees that policies should be transparent and based on forward-looking models “ The Committee [the FOMC] will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” From a Fed press release Sept 21, 2010 Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
A Rare Fed Comment on Fiscal Policy Usually the Federal Reserve avoids detailed comment on fiscal policy. In a departure from this tradition, Fed Chairman Ben Bernanke recently spoke out on the consequences of failing to face the nation’s fiscal problems honestly and early History makes clear that countries that continually spend beyond their means suffer slower growth in living standards . . . One way or the other, fiscal adjustments will certainly occur. The only real question is whether they will take place through a careful and deliberative process that weighs priorities and gives people plenty of time to adjust or whether they will be a rapid and painful response to a fiscal crisis. — Ben Bernanke October 4, 2010 Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ “ Fiscal Policy and Fiscal Rules,” Remarks in Providence, RI, Oct 4, 2010. Version above is slightly paraphrased to save space. Full text is available at http://www.federalreserve.gov/newsevents/speech/bernanke20101004a.pdf Photo source: Federal Reserve via http://commons.wikimedia.org/wiki/File:Ben_Bernanke_official_portrait.jpg
The Bottom Line Fiscal policy has major long-run effects on the economy, but decisions are too often made on the basis of short-term politics Everyone knows that changes in tax and spending policy must be made sooner or later, but there is great uncertainty over what those changes will be The resulting fiscal alchemy undermines the long-term planning on which growth and job creation depend Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

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The continuing resolution fiscal alchemy in action

  • 1. Free Slides from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ The Continuing Resolution: Fiscal Alchemy in Action? Post prepared October 5 , 2010 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.
  • 2. Congress Passes a Continuing Resolution Fiscal year 2011 —the new budget year for the U.S. government—began on October 1, 2010 On Sept. 29, Congress passed a continuing resolution that will allow the government to continue normal operations until December 3, 2010 Why is the continuing resolution a symptom of what a critic has called “fiscal alchemy?” Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ US Congress Appropriations Committee in Session, March 2008 Photo source: http://commons.wikimedia.org/wiki/File:FEMA_-_34403_-_FEMA_Administrator_at_Appropriations_Committee_Hearing_in_District_of_Columbia.jpg
  • 3. What is a Continuing Resolution? The Budget Process in Theory January: Congress receives President’s budget message Spring: House and Senate pass a resolution with overall budget goals No later than Oct 1: House and Senate pass 12 appropriations bills that are legally required to allow most government agencies to spend money Note: Entitlement programs like Social Security and Medicaid are not subject to annual appropriations Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ The Budget Process in Practice Political deadlock often prevents passage of appropriation bills by the Oct. 1 deadline Options if the appropriations bills are not passed on time: Pass a continuing resolution that lets each department temporarily continue to spend at the same rate as last year Shut down nonessential government functions until a bill is passed (longest shutdown occurred in 1995)
  • 4. Alchemy as the Precursor of Science In medieval times, many scholars investigated the natural world through the protoscience known as alchemy. The goals of alchemy included changing lead into gold and finding an “elixir of life” that would cure all diseases Alchemists never made gold from lead, but by intuition trial and error, they learned some useful things, like better methods of distillation Later, alchemy was displaced by modern scientific method based on theory, controlled experiments and testing of hypotheses The Alchemist, by William Fettes Douglas. Photo source: http://commons.wikimedia.org/wiki/File:William_Fettes_Douglas_-_The_Alchemist.jpg Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
  • 5. Monetary Science vs. Fiscal Alchemy* In a recent paper*, Eric Leeper has contrasted the science of monetary policy with what he calls fiscal alchemy “ Monetary policy decisions tend to be based on systematic analysis of alternative policy choices and their associated macroeconomic impacts: this is science. Fiscal policy choices, in contrast, spring from unsystematic speculation, grounded more in politics than economics: this is alchemy.” — Eric M. Leeper, Indiana University * “Monetary Science vs. Fiscal Alchemy,” Federal Reserve Jackson Hole Symposium, 2010 http://www.kansascityfed.org/publicat/sympos/2010/2010-08-16-leeper-paper.pdf Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Picture source: http://commons.wikimedia.org/wiki/File:Alembic.png
  • 6. Evidence of Fiscal Alchemy: Continuing Resolutions Continuing resolutions are a prime example of unscientific fiscal policy Very short horizon provides no framework for long-term expectations No attempt to optimize policy Continuing resolutions have become the norm, rather than the exception The budget was passed on time, without need for continuing resolutions, in only 3 of the 33 years covered in the chart Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
  • 7. Evidence of Fiscal Alchemy: Budget Projections The nonpartisan Congressional Budget Office has the duty of publishing a range of projections of the federal debt The lower limit, called the baseline scenario, shows what would happen with no policy changes The upper limit, or alternative scenario, shows what would happen if Congress makes changes similar to those made in the past Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Source:: Leeper, 2010, Figure 8
  • 8. Evidence of Fiscal Alchemy: Budget Projections Everyone knows the upper limit will not happen because it projects impossible levels of debt No one expects the lower limit to happen either because it omits changes that Congress is almost certain to make The range of estimates is very wide and getting wider, further contributing to the great uncertainty about future fiscal policy Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Source:: Leeper, 2010, Figure 8
  • 9. Contrast: Monetary Policy Aims for Stable Expectations In contrast to the short-term focus and great uncertainty about fiscal policy, the Fed and central banks of other developed countries attempt to provide a clearly-stated framework for monetary policy expectations Although monetary policy is not perfect and there are debates within and outside the Fed, everyone agrees that policies should be transparent and based on forward-looking models “ The Committee [the FOMC] will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” From a Fed press release Sept 21, 2010 Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
  • 10. A Rare Fed Comment on Fiscal Policy Usually the Federal Reserve avoids detailed comment on fiscal policy. In a departure from this tradition, Fed Chairman Ben Bernanke recently spoke out on the consequences of failing to face the nation’s fiscal problems honestly and early History makes clear that countries that continually spend beyond their means suffer slower growth in living standards . . . One way or the other, fiscal adjustments will certainly occur. The only real question is whether they will take place through a careful and deliberative process that weighs priorities and gives people plenty of time to adjust or whether they will be a rapid and painful response to a fiscal crisis. — Ben Bernanke October 4, 2010 Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ “ Fiscal Policy and Fiscal Rules,” Remarks in Providence, RI, Oct 4, 2010. Version above is slightly paraphrased to save space. Full text is available at http://www.federalreserve.gov/newsevents/speech/bernanke20101004a.pdf Photo source: Federal Reserve via http://commons.wikimedia.org/wiki/File:Ben_Bernanke_official_portrait.jpg
  • 11. The Bottom Line Fiscal policy has major long-run effects on the economy, but decisions are too often made on the basis of short-term politics Everyone knows that changes in tax and spending policy must be made sooner or later, but there is great uncertainty over what those changes will be The resulting fiscal alchemy undermines the long-term planning on which growth and job creation depend Post P101005 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/