Friday, July 29, 2011
Pro-cyclical fiscal policy
Cross-posted from Credit Writedowns
Balanced budget amendments are another one of these artificial constraints that look better on paper than they do in reality because they are procyclical.
In the euro zone, the stability and growth pact provides a 3% deficit hurdle which almost all of the euro zone breached during the recession. Austerity attempts to meet the hurdle have created larger deficits in the periphery (Spain, Greece, Portugal and Ireland).
The same problems were apparent in the US states where balanced budget amendments are the order of the day. Before Barack Obama entered the White House, I asked in January 2009 “Will federal largesse be countered by state and local cutbacks?” By June 2010, it was obvious the answer was yes. That’s what procyclicality means.
Procyclicality is fine for states as a constraint despite how it exacerbates the swings in the business cycle, and creates deadweight losses. That is because the federal government can always counter this pro-cyclicality and smooth out the cycle. Procyclicality is one of the structural flaws of the euro zone; there is no federal agent to do counter procyclical budget cuts during a recession. Thus, the euro zone business cycle will invariably be volatile, making current account imbalances a lightening rod for intra-European recrimination.
Now, America is looking to impose the same sort of procyclicality on the US federal government.
When downturns hit, revenues drop because tax receipts drop due to income shortfalls and spending increases because of automatic stabilisers. So, a balanced budget amendment would require even more cuts. But since those cuts reduce income and tax receipts, you need enough cuts to overcome the negative revenue effects on the budget. That means a balanced budget amendment would require deep, deep cuts in federal spending at precisely the worst moment in the business cycle.
SOU 2002:16, Stabiliseringspolitik i valutaunionen, slutbetänkande samt underlagsrapporter
Svenskt Näringsliv får härmed avge följande synpunkter på rubricerat betänkande.
Svenskt Näringsliv avstyrker det föreslagna finanspolitiska rådet.
Det finns inget behov för ett sådant eftersom vi anser att aktiv stabiliseringspolitik inte skall bedrivas.