Economy and Politics

Are you better off now than you were four years ago Economy performing poorly, presidents lose 1960 Nixon, Carter 1980, Bush in 1992

Economy performing well, presidents win LBJ 1964, Nixon 1972, Reagan 1984, Clinton 1996

Important for Congress and Realignment

Macroeconomic Policy

Fiscal- change tax and spending policy

Monetary- change money supply

Microeconomic policyEducation, labor, technology,

transportation, subsidies to industry etc

Fiscal Policy

Keynes- govt can fine tune the economyRecession- Government run deficits, stimulate demandProsperity- run surpluses, cool economy, prevent inflation JFK/LBJ tax cut and 1960s boom

Limits of Fiscal Policy

Political Limitations love the gas; hate the breaks slow response time

Economic Limitations- is economy growing or receding?

Erosion of Fiscal Flexibility The sticky pedal Anti- tax movement

Budget on Autopilot

Budget Outlook 1995-99, CBO

Entitlements51%

Interest13%

International Affairs

1%Defense20%

Domestic15%

Federal Govt Receipts, CBOTaxes as % of GNP

5.9

1.53.8 3.8

9.1

4.5 4.93.4

8.57

1.1 1.2

0

5

10

IndividualIncome

Payroll CorporateIncome

Other

1950

1970

1990

MONETARISM

#1 tool--raising or lowering interest rates Reduce interest rates, increase supply of money, people borrow more, economy grows.Big advantage– speed

THE FEDERAL RESERVE SYSTEM

Fed Board of Governors, Federal Reserve Banks, FOMCWill Rogers, "there are two things that can disrupt the American economy. One is a war. The other is a meeting of the Federal Reserve Board."

Who is this Man?

Interest Rates & the Fed

Fed recently increased interest ratesWho made that decision?Any Guesses?

Insulation for Politics

Raise their own budgetBowling alleys on Wall Street!!!

Appointment process & 14 year termsBusiness confidence in FedMonetary policy too arcane

Jawboning

Congressional Hearing on FedGreenspan's "We have to bring the existing instabilities to a level of stability reasonably shortly. I think we know where we have to go. I do not think we underestimate the severity of the problems with which we are dealing," Investors-- quarter-point rate cut is coming

Is independence A Good Idea?

Improves mgmt of economy, fewer recessions,

Politicians hate to take away the punch bowl as the party gets going

Odysseus and the Sirens

BANKER DOMINANCE

Fed is Iron Triangle with BankersBankers nominate the Federal Reserve bank presidents who cast five votes on the Open Market Committee Obsession with fighting inflationPeople who benefit from low inflation, are not those who suffer from high unemployment!!!!!!!!

MONETARISM

#1 tool--raising or lowering interest rates Reduce interest rates, increase supply of money, people borrow more, economy grows.Big advantage– speed

Interest Rates & the Fed

Fed recently increased interest ratesWho made that decision?Any Guesses?

The Maestro

FOMC

Insulation for Politics

Raise their own budgetBowling alleys on Wall Street!!!

Appointment process & 14 year termsBusiness confidence in FedMonetary policy too arcane

Minnesota Fed Bank

Jawboning

Congressional Hearing on FedGreenspan's "We have to bring the existing instabilities to a level of stability reasonably shortly. I think we know where we have to go. I do not think we underestimate the severity of the problems with which we are dealing," Investors-- quarter-point rate cut is coming

Is independence A Good Idea?

Improves mgmt of economy, fewer recessions,

Politicians hate to take away the punch bowl as the party gets going

Odysseus and the Sirens

Bias of the Fed

Bankers nominate the Federal Reserve bank presidents who cast five votes on the Open Market Committee Obsession with fighting inflationNAIRU- 6%People who benefit from low inflation, are not those who suffer from high unemployment!!!!!!!!

Political Business Cycle

Pres manipulate economy to engineer their reelections

Success– Bush and Reagan

Failures– Carter and Bush

Budget Deficits

Major issue in American politicsSolution is simple, cut benefits, raise taxesCitizens wants less taxes; cut spending for welfare, foreign aid, and space. Politicians seek seek blame avoidance techniques

Bracket Creep

Let Inflation work for you!Auto cuts in benefits and taxesCongress never has to raise taxes

End of Bracket CreepPoliticians can no longer avoid taxes

Where do Taxes come from/go?

Taxes- What Economists Like

broad based taxes Income taxExcise taxSales tax

What elected officials (and voters) like

Tax preferences/deductionsGood or BadCharities, education, local taxes, mortage

interest"warfare welfare" $7.6 billion "mansion subsidiary" $6.7 billion "skybox scandal" $5.5 billion

Problems with preferences

Tax Reform

2 main issues-- the breadth and progressivity of the tax system 1986 tax reform1993 34% upper bracket

Flat Tax18% for everyoneReduce loopholes

Flat Tax--Con

Would hurt charities, home buyers

Would not raise enough money

Main beneficiaries would be wealthy$24,650 taxed at a 15 percent rate $50,000 taxed at 28% rate$1 million taxed at 36% rate

Flat Tax- pro

Why penalize hard work, investment

Simplicity

Internet world

Already have a flat tax-- Social insurance taxes