February 22, 2018

Trump Embarks on a Gigantic Fiscal Experiment

Tyler Cowen

Holbert L. Harris Chair of Economics at George Mason University

Noah Smith


Government usually tries to lower debt and deficits during economic expansions. Not this time.

Typically, during an economic expansion, central governments try to restrain spending and raise taxes to pay down debt accumulated during recessions -- at least that’s the theory. Not this time. Bloomberg View economics columnist Tyler Cowen and Noah Smith met online to debate what’s different now. 

Tyler Cowen: I think you’ve noticed that the Trump administration, with support from Congress, has plans to raise the federal debt and deficit. I’ve seen estimates that the tax-cut bill will add at least $1 trillion to the debt over a 10-year period, and for over the next two years Congress just approved about $500 billion in new spending.

I don’t see many fiscal conservatives left anymore, although I am one of them, and so I find these developments distressing on net. But not everyone feels the same way. I’ve been noticing that many Republicans and conservatives are more sympathetic to deficits than they used to be, and many on the left are more critical than under President Barack Obama. It had been a staple of Keynesian thought that so-called secular stagnation might require steady and growing deficits to boost aggregate demand, even in a time of recovery. Now I mostly hear criticisms of President Donald Trump’s deficits and talk that private investment will be crowded out.

What do you make of this, Noah? Is there actually a correct, nonpartisan way to approach fiscal policy, or is it doomed to be the handmaiden of politics?

Noah Smith: Fiscal policy is always going to be political. I think of it like a game-theory equilibrium -- as long as everyone believes that deficits raise growth in the short-term, anyone with a partisan slant is going to push for deficits while their party is in power and push for austerity when their party is out of power. Of course, this means the debt will tend to rise over time. Let’s hope -- and here I’m assuming that the modern monetary theory people are wrong and that there is such a thing as an unsustainable deficit -- the loyal opposition can keep it from rising too fast. It’s also possible that if debt does get so high that it starts undermining business confidence and harming the economy, people will recognize this and drop the belief that deficits are good for growth -- as Bill Clinton did in the 1990s.

In terms of actual policy, Trump’s deficits -- like the deficits of George W. Bush and Ronald Reagan before him -- seem badly timed because they’re procyclical. Keynesian theory says you should run deficits when the economy is in recession and then do austerity in the boom. Yet somehow our presidents keep forgetting that second part. Why do you think that is? And is it just coincidence that it keeps being Republican presidents who run up the debt in good times?

TC: I have a proposed rule for fiscal policy: Invest in good projects and good projects only, based on a cost-benefit test. That sounds trivial, but in reality hardly anyone follows it or even agrees.

I do understand that Keynesian macroeconomic theory suggests that in a downturn we should lower our standards for project evaluation, so as to boost aggregate demand with more spending. I’m not persuaded. For one thing, governments don’t always do a good job finding and targeting unemployed resources. For another thing, spending on wasteful projects turns public opinion against government, and this just isn’t worth it. Keynes’s recipe for spending money on wasteful pyramids, even if good economics, is a public-relations disaster and very bad advice.

But Noah, I have a question for you. You’ve written several columns about how the American economy is becoming more monopolistic. If true (and it is not exactly my view), that implies output could be much higher with current resources, even at full employment. A boost in demand could spur firms to produce more, rather than restricting output so much. So are you now a fan of these Trumpian deficits? They may not be your preferred form of deficit spending, but do you see them still as a net positive?

NS: Your proposed rule basically says government spending should be no different in recessions than in booms. This rehashes the debates from the Great Recession.

Some people doubted the existence of Keynesian demand effects. But the empirical literature is as conclusive as macro empirics can be -- stimulus does boost the economy to some degree. Even the International Monetary Fund, which used to recommend austerity in crises, has reversed itself and now believes in stimulus.

As for boondoggles, it seems highly unlikely that repairing dilapidated roads and bridges, or plugging holes in state budgets, will be seen as white elephants.

As you say, monopoly power could potentially increase the case for stimulus in bad times. But if you believe government debt can get too large -- as most people probably still believe -- you should reduce deficits, or even pay down some debt, during economic good times.

I have a question for you: Do you think the economy is doing well right now?

TC: I would rather rely on monetary policy for my stimulus, and indeed the Federal Reserve could have done more during some critical periods. Was Obama’s fiscal stimulus so popular? And are you happy with how our politics turned out? So many people had the impression that the government was spending their money on the government’s priorities, and in response we’ve ended up with a dysfunctional populism.

I think a lot of road and bridge repair would pass the cost-benefit test I suggested above, so that needn’t be left undone.

Don’t forget, if you believe in high and growing monopoly power, you might wish for stimulus in good times too -- the resulting higher output will help pay for it. In contrast to your views, however, I don’t see that American industry has been restricting output at anything but normal historical levels.

I still see poor productivity performance, and I’m not convinced we are investing in the right ways to boost future living standards. So, while many economic variables are rosier than a few years ago, we are not yet in the clear. What do you think?

NS: I don’t think running government deficits is the proper way to deal with monopoly power -- for that, we should use stronger antitrust legislation.

It’s hard to evaluate the effect of the 2009 stimulus on long-term political outcomes, given all the confounding factors, but it does seem like it was reasonably popular at the time. As economist Robert Lucas put it at the time, “Everyone is a Keynesian in a foxhole.” Perhaps that’s as it should be, since we are no longer in anything remotely resembling a foxhole.

Raising productivity is certainly a priority. Some Keynesians do believe that stimulus spending can raise productivity, even during a boom. For all our sakes, let’s hope they’re right. And let’s also hope that the people who argue that deficits don’t matter are right. Because one thing’s for certain -- the Republicans are about to send deficits a lot higher.