Uncertainty and Economic Growth



I refinanced my mortgage yesterday. In between signing papers, the title attorney saw my profession listed as "Economist" and asked me what I thought about the economy. I stuck with my simplified "Well, manufacturing is doing poorly, but people seem to still be buying things, so I'm not sure" explanation. But on the way home, I got to thinking more about how the economy got to where it is, and perhaps what it would take to get it running again. We had a hell of a run during the 1990's. Pretty much from 1993 until 2001 the economy just wouldn't stop. Then in 2001, the economy faltered. September 11th was another blow to it. Since then, to use another metaphor, it seems like we're up to the axles in mud and not able to get any traction to get out of the quagmire of low investment, low hiring, and low growth.

One thing that we can point to during much of the roaring nineties is a relatively consistent government fiscal policy toward eliminating the budget deficit, and a monetary policy toward low inflation. Since 2001, the Bush administration has made much of changing the rules and cutting taxes, without regard to the fiscal situation of the federal government. I recognize that cutting taxes can increase growth in the economy. (As an aside, I tend toward a post-Keynesian view that while cutting taxes can stimulate growth, increasing government spending will actually cause more growth due to a stronger multiplier effect.) The problem with cutting taxes, either because it’s a moral precept or because it will encourage growth, is that it is changing the rules, and introducing uncertainty into the economy. The uncertainty ties into those “animal spirits” that are said to drive many of our economic decisions. The uncertainty makes us more skittish, more focused on short-term at the expense of the long-term.

The way to correct this is a stated fiscal policy goal. It doesn’t have to be a balanced budget. It could be a target deficit of $100 billion if GDP growth is below 3 percent, and a balanced budget if GDP growth is over 3 percent. But it needs to be something consistent, something knowable, so that the uncertainty of fiscal policy does not drag on the economy.

I don't see this happening, though.

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