I will complete my overview of Alan Blinder’s Monetary and Fiscal History of the United States, 1961-2021, by discussing the three other themes he sees in the story of those years.
Who sits in the first chair, fiscal policy or monetary policy?
This theme is closely related to the changing fortunes of Keynesian theory and policy, since Keynesianism makes heavy use of fiscal policy. Prior to the Keynesian ascendancy in the Kennedy-Johnson years, neither fiscal nor monetary policy preoccupied government leaders. The deliberate manipulation of spending, taxing, or interest-rate levels to stimulate or constrain the economy would mostly come later.
The success of the Kennedy-Johnson tax cuts put fiscal policy in the “first chair,” but only briefly. Richard Nixon relied on both expansionary fiscal policy and loose monetary policy—through his influence on Fed Chair Arthur Burns—to boost the economy prior to his reelection in 1972.
The inflation of the 1970s focused attention on monetary theory and policy. On the one hand, Milton Friedman laid the blame for inflation squarely on the Federal Reserve for expanding the money supply too rapidly. On the other hand, economists began to question the effectiveness of fiscal policy for combating unemployment. The high interest rates imposed by the Federal Reserve under Paul Volcker were the most notable policy of the early 1980s. Fiscal policy remained somewhat expansionary, however, since Ronald Reagan was more successful in cutting taxes than cutting spending.
In the 1990s, fiscal policy was a major focus of the Clinton administration, but the emphasis was on deficit reduction rather than economic stimulus. Blinder believes that Fed Chair Alan Greenspan handled monetary policy very well in this period, with interest rates low enough to avoid recession but high enough to control inflation.
Fiscal policy turned deliberately expansionary after 2000, as Presidents George W. Bush and Donald Trump both cut taxes and increased spending. It became even more expansionary when the Obama and Biden administrations spent even more to combat the severe recessions following the financial crisis of 2007 and the pandemic of 2020. Monetary policy was very active in this period as well, with cuts in interest rates and other measures to keep financial markets liquid.
Which dominated, fiscal policy or monetary policy? Before the 1960s, neither; then briefly, fiscal policy (Kennedy-Johnson); then at times, monetary policy (Volcker). In recent decades, both have played major roles.
The rise of central bank independence
As policymakers came to appreciate the importance of monetary policy for managing the economy, they also came to respect the independence of the Federal Reserve Bank. Government spending and taxing decisions are heavily political, but Blinder agrees with the many economists who argue that central bank decisions can and should be less so. “[F]iscal policy decisions will continue to be made largely on political grounds while monetary policy decisions will continue to turn on technocratic, economic considerations. The twain will not soon meet.”
Blinder says that Richard Nixon’s collaboration with Fed Chair Arthur Burns was probably the low point for central bank independence (CBI). When Paul Volcker took over in 1979, the situation changed. “The virtues of CBI have rarely been questioned since then, at least not in the United States.”
That does not mean that political leaders have always been happy with the Fed’s decisions. Donald Trump complained that interest rates were too low during the Obama administration, and then complained they were too high during his own administration. But the Fed continued to go its own way.
Do budget deficits matter?
Back in the Eisenhower era, deficits were commonly regarded as “fiscally imprudent” and even “morally repugnant.” Deliberately risking a budget deficit to stimulate the economy was a bold move when the Kennedy-Johnson administration first proposed it. Many economists wanted Keynesian policies to be symmetric—calling for deficit increases in bad times but deficit reductions in better times. In practice, tax cuts and spending increases turned out to be easier to initiate than to reverse.
Many leaders tried to maintain their theoretical commitment to balanced budgets even as they ran up deficits. Voters were attracted to Reaganomics, which promised both immediate tax cuts and eventual balanced budgets. When the balanced budgets failed to materialize, it fell primarily to Bill Clinton to eliminate the deficit with a combination of tax increases and spending cuts. Then when the Republicans returned to power, the deficits started growing again.
Since 2000, both major parties have contributed to normalizing large deficits. Republicans have done it mainly by cutting taxes, while Democrats have done it mainly by protecting popular spending programs. Democrats have also provided more of the support for fiscal stimulation to counteract severe recessions, with occasional help from Republicans. Republicans call more loudly for spending cuts, but rarely deliver them when they are in power.
Here I will add some thoughts about the current situation. For the fiscal year just ended, federal outlays were about $6.4 trillion, revenues about $4.8 trillion, leaving a deficit of about $1.6 trillion. Eliminating the deficit without raising revenues would require an across-the-board spending cut of 25%. However, neither party is eager to be accused of weakening the nation’s defenses or cutting popular benefit programs like Social Security, Medicare, unemployment compensation or veterans’ benefits. Such programs, plus interest on the existing debt, constitute 84% of the federal budget! The debate over budget cuts centers on the “nondefense discretionary” spending that remains, which covers everything else the federal government does from medical research to air-traffic controllers, border security, federal law enforcement, food and drug regulation, etc., etc.
Suppose Congress were to cut all nondefense discretionary programs by 30%, as a recent Republican proposal called for. That would save about $300 billion a year, but that would still leave about 80% of the deficit untouched. And because government is a labor-intensive activity, it would cause massive unemployment in the federal workforce and severe disruptions to government services. That’s why no serious proposal for reducing the deficit can overlook the biggest parts of the budget or refuse to consider rolling back some of the Republican tax cuts for corporations and the wealthy.
Serious deficit reduction would require bipartisan support for a combination of spending reductions and revenue increases. That is not a very likely prospect, considering that House Speaker Kevin McCarthy got voted out of office just for allowing a vote on a bipartisan resolution to avoid a government shutdown. The resolution in question was supported by 77% of House members, but it went against the hardliners’ effort to hold the government hostage until it adopted their agenda. Those folks were following Donald Trump’s mandate—“UNLESS YOU GET EVERYTHING, SHUT IT DOWN!” That pretty well summarizes the MAGA philosophy of governing, as well as reveals its contempt for the democratic process.
Getting back to the deficit, Blinder does not mention a new economic theory with Keynesian roots, “Modern Monetary Theory” (MMT), probably because it has yet to achieve much acceptance in mainstream economics. Its proponents argue that a nation with “sovereign monetary authority” can sustain deficits better than a household or other entity that lacks control over its own money supply. A good introduction to it is Stephanie Kelton’s The Deficit Myth.
Do deficits matter? Apparently not as much as they used to, considering how long we have been living with them. There will always be limits, but they are probably not as severe as we once thought.
Beneath the Surface 