Academic journal article The Economic and Labour Relations Review : ELRR

Discretionary Fiscal Policy and Budget Deficits: An 'Orthodox' Critique of Current Policy Debate

Academic journal article The Economic and Labour Relations Review : ELRR

Discretionary Fiscal Policy and Budget Deficits: An 'Orthodox' Critique of Current Policy Debate

Article excerpt


A solid majority of economists is now of the opinion that, even in a capitalist system, full employment may be secured by a government spending programme, provided there is in existence adequate plant to employ all existing labour power and provided adequate supplies of necessary foreign raw materials may be obtained in exchange for exports (Kalecki 1943: 420).

Over the past few decades, discretionary fiscal policy of the form perceived by Kalecki has not been a central component of macroeconomic policy formulation. Instead, 'neutral' and 'responsible' fiscal policy has been widely advocated, taken to correspond to the achievement and maintenance of balanced or surplus budgets (across the cycle) and reductions in the stock of Government debt. This policy stance is, for example, asserted directly in the most recent Australian Government's Budget papers:

The Government's fiscal strategy aims to ensure fiscal sustainability over the medium term. The Government's medium-term fiscal strategy involves:

* achieving budget surpluses, on average, over the medium term;

* keeping taxation as a share of GDP on average below the level for 2007-08; and

* improving the Government's net financial worth over the medium term (Australian Commonwealth Government 2008: 1.4).

Similar principles are found in fiscal policy strategy statements in many other countries, perhaps most significantly in the EU fiscal policy framework enshrined in the Stability and Growth Pact and Article 104 of the EC (Maastricht) Treaty. Here, a rules-based fiscal policy was instituted in an attempt to ensure that member states avoid excessive government deficits. These policy rules were defined in terms of the achievement of deficit and debt-to-GDP ratios, with subsequent modifications allowing for 'temporary' departures from these guidelines under specific and verifiable circumstances. Within the EU framework, 'neutrality' of fiscal policy is emphasised, with European Central Bank (ECB)-implemented monetary policy, primarily targeting price stability, being the chosen instrument for discretionary macroeconomic policy actions. (1)

The 'neutral' and 'responsible' principles of 'sound' fiscal policy continue to be put forward in opposition to the calls for significant fiscal stimulus during the current global economic downturn. While expansionary monetary policy and central bank 'rescue packages' for financial institutions have met with fairly widespread approval, incumbent governments have struggled to convince their electorates that expansionary fiscal policy in the shape of budget deficits represents a 'responsible', and indeed essential, fiscal policy stance. In terms of the current debate within Australia, one can only suspect that when the fiscal budget goes into deficit, the (self-proclaimed 'fiscal conservative') Government will feel obliged to issue an 'apology' to its apprehensive electorate and face censure and derision from the opposition coalition parties who seek to equate budget deficits with 'fiscal negligence'.

The purpose of this article is not primarily to develop a critique of orthodox macroeconomic theory, although there are certainly compelling grounds upon which such a critique could be constructed. Instead, its major purpose is to counter some of the naive interpretations of orthodox theory that appear to have informed much of the current discussion of the role and effectiveness of fiscal policy. Firstly, it is argued that an active role for discretionary fiscal policy is not inconsistent with a considered interpretation of what may be construed to be mainstream economic analysis, both in terms of the traditional textbook models and the more recently formulated New Neoclassical Synthesis (NNS) approaches. Secondly, the idea that there is something inherently 'irresponsible' or 'profligate' with budget deficits is shown to rest on a rather antiquated view of public finance which fails to encompass the realities of endogenous money and interest rate targeting monetary policy. …

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