Rational Expectations Theory and Macro Budgetary Decision-Making: Comparative Analysis of Canada, Uk, and USA

Article excerpt

ABSTRACT. An exciting opportunity that many advanced industrial democracies faced in the late 1990s was the movement from budgetary deficit to surplus. This came after years of persistent deficits. Traditional decision-making theories such as budgetary incrementalism failed to explain this long-run relationship, since it has been inherently a short-run theory. This paper uses rational expectations theory to demonstrate its relationship to budgetary decision-making reforms and the deficit (surplus) for Canada, the UK and the United States. The results demonstrated that there was an intertemporal budget constraint in operation in the three countries, and decision-makers at the macro level used rational expectations in the formulation of their annual budget. In the theory, budget actors strived to balance their budget, but did so over the long-run as opposed to the short-run incrementalist interpretation.

INTRODUCTION

In the late 1990s, many advanced industrial countries faced budgetary surpluses after years of persistent deficits. Notably Canada, the United Kingdom (UK) and the United States (US) had a difficult struggle with budgetary deficits from about the mid-1970s until the late 1990s. This paper compares budgetary reforms and the surplus (deficit) in Canada, the UK and the US during the post World War II period and demonstrates their relationship to the rational expectations theory. These countries were chosen because of their differences, most importantly, presidential and parliamentary institutional arrangements and their impact on the budget. In a parliamentary system, the legislative branch's power to alter the executive budget is quite limited.

Indeed, under parliamentary systems of Canada and the UK, the government budget is accepted (or rejected) as a whole without amendment or modifications. By contrast, in the US budget making practices, the President 'proposes' and Congress 'disposes' the budget. The US Congress is free to change the President's budget priorities or substitute one of its own.

One fundamental question that this paper poses is: What long-run theory can be used to explain the movement from budget surplus to deficit to surplus over the past thirty years in these countries? The budgetary process has not always been in turmoil, and on most occasions before World War II, the system was able to balance competing claims on resources and produce balanced budgets. The pre-World War II period was a time when many scholars would agree that incrementalism occurred in public budgeting when line-item budgeting took place. This was due to the process of how decisions were made in government. It was easier to produce incremental changes than plan ahead. Incremental changes require less information from decision-makers; therefore, they are easier to make in the political setting. Information has become more plentiful and easier to process with advances in information technology and this has made rational comprehensive decisions very plausible in contemporary public administration (Barrett & Greene, 2001; Danziger & Andersen, 2002). For example, in the late 1990s, the Y2K problem gave public managers the opportunity to become more proficient in information technology in order to recommend the replacement of legacy systems, updated to client/server models creating networked enterprises.1

Another question to be asked is: Why has there been a persistent attempt to reform the budget systems? Governments want to reform budgets to control public spending and institute priorities. More specifically, the executive wants to establish authority over budget allocations to implement its desired agenda. A large part of the literature on budgeting in the United States, Canada, and the UK is concerned with reform (Knott & Miller, 1987). The goals of the proposed reforms are couched in similar languages such as economy, efficiency, and most recently, results. Proposed reforms inevitably contain important implications for the political system. …