fiscal policy

Inflation Is Largely a Global Phenomenon

When economic journalists speculate about looming inflation risks in the U.S. or any other country, they implicitly assume that each country’s inflation depends on that country’s fiscal or monetary policies, and perhaps the unemployment rate. Yet The Economist for March 3rd–9th shows approximately 1–2 percent inflation in the consumer prices index (CPI) for virtually all major economies. 

Inflation rates were surprisingly similar regardless of whether countries had budget deficits larger than ours (Japan and China) or big surpluses (Norway and Hong Kong), regardless of whether central banks experimented with “quantitative easing” or not, and regardless of whether a country’s unemployment rate was 16.9 percent (Spain) or 1.3 percent (Thailand). 

The latest year-to-year rise in the CPI was below 1 percent in Japan and Switzerland, 1.5 percent in Hong Kong and the Euro area, 1.6 percent in Canada and China, 1.8 percent in Sweden, 1.9 percent in Norway and Australia, 2 percent in South Koreas and 2.1 percent in the U.S.  Among major countries, U.K. was on high side with inflation of 2.7 percent.  Three economies with super-fast economic growth above 6 percent (India, Malaysia and the Philippines) do have slightly higher inflation—above 3 percent—but the CPI is up just 1.6 percent in one of them, namely China. 

Major Country Inflation

The remarkable similarity of CPI inflation rates is surprising since countries measure inflation differently and consume different mixes of goods and services. The fact that inflation rates are nonetheless so similar, and move up and down together, suggests that inflation is largely a global phenomenon.  The U.S. may well have a disproportionate influence on global inflation, since it accounts for about 24 percent of global GDP and key commodities are priced in U.S. dollars.  Yet U.S. inflation nonetheless goes up and down in synch with other major economies, as the graph shows. 

Would a Chilean-style Fiscal Rule Work for the US?

It was reported last week that a Republican working group is considering a proposal to link spending caps to the growth of actual or potential GDP. This is encouraging, and much more economically sensible than rigid balanced budget legislation.

I’ll write about other countries’ experiences with backward-looking rules in the future. But one country which uses forward-looking estimates of potential GDP to determine overall government spending is Chile. Indeed, economists such as Jeffrey Frankel have previously written glowingly about Chile’s fiscal rule, which Frankel concluded had constrained government debt whilst being flexible enough to allow automatic stabilizers to operate.

First, some background: in 2000 the Chilean government voluntarily adopted a structural budget surplus rule of one percent of GDP each year. This was lowered to half a percent of GDP in 2007, and then to a simple balanced structural budget rule in 2009 once government debt had essentially been paid off.

What does this mean in practice? A committee of independent experts meets once a year to provide the government with estimates of potential GDP. A separate committee assesses whether copper prices (a key driver of revenues) are higher or lower than trend. These two opinions are put together to determine an estimate of government revenues for the year if the economy was operating at its potential with copper prices at their long-term level. This determines the total maximum spending level allowed in the budget plan for the year. In other words, spending is capped based upon an estimate of tax revenues if the economy was at potential.

Republicans Embrace Bad Economics and Bad Policy

To be blunt, Republicans are heading in the wrong direction on fiscal policy. They have full control of the executive and legislative branches, but instead of using their power to promote Reaganomics, it looks like we’re getting a reincarnation of the big-government Bush years.

As Yogi Berra might have said, “it’s déjà vu all over again.”

Let’s look at the evidence. According to The Hill, the Keynesian virus has infected GOP thinking on tax cuts.

Republicans are debating whether parts of their tax-reform package should be retroactive in order to boost the economy by quickly putting more money in people’s wallets.

That is nonsense. Just as giving people a check and calling it “stimulus” didn’t help the economy under Obama, giving people a check and calling it a tax cut won’t help the economy under Trump.

Tax cuts boost growth when they reduce the marginal tax rate on productive behavior such as work, saving, investment, or entrepreneurship. When that happens, people have an incentive to generate more income. And that leads to more national income, a.k.a., economic growth.

Borrowing money from the economy’s left pocket and then stuffing checks (oops, I mean retroactive tax cuts) in the economy’s right pocket, by contrast, simply reallocates national income.

Three Lessons from the Tax Defeat in Kansas

Leftists don’t have many reasons to be cheerful.

Global economic developments keep demonstrating (over and over again) that big government and high taxes are not a recipe for prosperity. That can’t be very encouraging for them.

They also can’t be very happy about the Obama presidency. Yes, he was one of them, and he was able to impose a lot of his agenda in his first two years. But that experiment with bigger government produced very dismal results. And it also was a political disaster for the left since Republicans won landslide elections in 2010 and 2014 (you could also argue that Trump’s election in 2016 was a repudiation of Obama and the left, though I think it was more a rejection of the status quo).

But there is one piece of good news for my statist friends. The tax cuts in Kansas have been partially repealed. The New York Times is overjoyed by this development.

The Republican Legislature and much of Kansas has finally turned on Gov. Sam Brownback in his disastrous five-year experiment to prove the Republicans’ “trickle down” fantasy can work in real life — that huge tax cuts magically result in economic growth and more, not less, revenue. …state lawmakers who once abetted the Brownback budgeting folly passed a two-year, $1.2 billion tax increase this week to begin repairing the damage. …It will take years for Kansas to recover.

And you won’t be surprised to learn that Paul Krugman also is pleased.

The Five Most Important Takeaways from Trump’s Budget

It’s both amusing and frustrating to observe the reaction to President Trump’s budget.

I’m amused that it is generating wild-eyed hysterics from interest groups who want us to believe the world is about to end.

But I’m frustrated because I’m reminded of the terribly dishonest way that budgets are debated and discussed in Washington. Simply stated, almost everyone starts with a “baseline” of big, pre-determined annual spending increases and they whine and wail about “cuts” if spending doesn’t climb as fast as previously assumed.

Here are the three most important things to understand about what the President has proposed.

First, the budget isn’t being cut. Indeed, Trump is proposing that federal spending increase from $4.06 trillion this year to $5.71 trillion in 2027.

 

Paul Krugman on Pump-Priming and Trump

New York Times columnist Paul Krugman recently chided President Trump for imagining he invented the metaphor of “priming the pump” during an Economist interview. Yet Krugman, like Trump, buys into the premise that budget deficits really do “stimulate” total spending or “aggregate demand” which is commonly measured by growth of Nominal GDP (NGDP).

Economic booms and busts clearly have huge effects on budget deficits, but where is the evidence that deficits and surpluses have their own separate (“exogenous”) effect on NGDP? 

To isolate cause and effect, we have to take out the “endogenous” effects that ups and downs in the economy have on taxes and spending. That is why the Congressional Budget Office (CBO)estimates budget deficits or surpluses (divided by GDP) without automatic stabilizers, which has traditionally been called the “cyclically-adjusted” budget. I will label it the “C-A Deficit” for short.  

CA Deficit and NGDP

The red line in the graph shows the CBO’s Cyclically-Adjusted (C-A) deficit or surplus as a share of GDP. The blue line shows the percentage growth in Nominal GDP (NGDP). 

From 1965 to 2016, the C-A Deficit averaged -2.7% of GDP, and growth of nominal GDP averaged 6.6%.

Contrary to 1960s Keynesian orthodoxy, the graph and table reveal no connection between the size of cyclically-adjusted deficits or surpluses and the rate of growth of aggregate demand (NGDP).  From 1991 to 2001, for example, the C-A Budget swings from an average deficit to a sizable surplus with essentially no change in the pace of NGDP growth. 

There is no measurable or even visible connection between larger CA-Deficits and faster NGDP growth in 2009-2012, nor between budget surpluses and slower NGDP growth in 1998-2000.  For more than 50 years, our experience has frequently been the opposite of what demand-side fiscalism predicts. This is not just a short-term phenomenon.

Supporters of BATs and VATs are wrong about trade and taxes

My crusade against the border-adjustable tax (BAT) continues.

In a column co-authored with Veronique de Rugy of Mercatus, I explain in today’s Wall Street Journal why Republicans should drop this prospective source of new tax revenue.

…this should be an opportune time for major tax cuts to boost American growth and competitiveness. But much of the reform energy is being dissipated in a counterproductive fight over the “border adjustment” tax proposed by House Republicans. …Republican tax plans normally receive overwhelming support from the business community. But the border-adjustment tax has created deep divisions. Proponents claim border adjustability is not protectionist because it would automatically push up the value of the dollar, neutralizing the effect on trade. Importers don’t have much faith in this theory and oppose the GOP plan.

Much of the column is designed to debunk the absurd notion that a BAT is needed to offset some mythical advantage that other nations supposedly enjoy because of their value-added taxes.

Here’s what supporters claim.

Proponents of the border-adjustment tax also are using a dodgy sales pitch, saying that their plan will get rid of a “Made in America Tax.” The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds persuasive, at least until you look at both sides of the equation.

When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

Here’s a visual depiction of how the current system works. I include the possibility that that German products sold in America may also get hit by the US corporate income tax (if the German company have a US subsidiary, for instance). What’s most important, though, is that neither American-produced goods and services nor German-produced goods and services are hit by a VAT.

Six Sobering Charts about America’s Grim Future from CBO’s New Report on the Long-Run Fiscal Outlook

I sometimes feel like a broken record about entitlement programs. How many times, after all, can I point out that America is on a path to become a decrepit European-style welfare state because of a combination of demographic changes and poorly designed entitlement programs?

But I can’t help myself. I feel like I’m watching a surreal version of Titanic where the captain and crew know in advance that the ship will hit the iceberg, yet they’re still allowing passengers to board and still planning the same route. And in this dystopian version of the movie, the tickets actually warn the passengers that tragedy will strike, but most of them don’t bother to read the fine print because they are distracted by the promise of fancy buffets and free drinks.

We now have the book version of this grim movie. It’s called The 2017 Long-Term Budget Outlook and it was just released today by the Congressional Budget Office.

If you’re a fiscal policy wonk, it’s an exciting publication. If you’re a normal human being, it’s a turgid collection of depressing data.

But maybe, just maybe, the data is so depressing that both the electorate and politicians will wake up and realize something needs to change.

I’ve selected six charts and images from the new CBO report, all of which highlight America’s grim fiscal future.

The first chart simply shows where we are right now and where we will be in 30 years if policy is left on autopilot. The most important takeaway is that the burden of government spending is going to increase significantly.

The United Kingdom and the Benefits of Spending Restraint

When I debate one of my leftist friends about deficits, it’s often a strange experience because none of us actually care that much about red ink.

I’m motivated instead by a desire to shrink the burden of government spending, so I argue for spending restraint rather than tax hikes that would “feed the beast.”

And folks on the left want bigger government, so they argue for tax hikes to enable more spending and redistribution.

I feel that I have an advantage in these debates, though, because I share my table of nations that have achieved great results when nominal spending grows by less than 2 percent per year.

The table shows that nations practicing spending restraint for multi-year periods reduce the problem of excessive government and also address the symptom of red ink.

I then ask my leftist buddies to please share their table showing nations that got good results from tax increases. And the response is…awkward silence, followed by attempts to change the subject. I often think you can even hear crickets chirping in the background.

I point this out because I now have another nation to add to my collection.

From the start of last decade up through the 2009-2010 fiscal year, government spending in the United Kingdom grew by 7.1 percent annually, far faster than the growth of the economy’s productive sector. As a result, an ever-greater share of the private economy was being diverted to politicians and bureaucrats.

Beginning with the 2010-2011 fiscal year, however, officials started complying with my Golden Rule and outlays since then have grown by an average of 1.6 percent per year.

Pages

Subscribe to RSS - fiscal policy