Bosworth, Barry, Federal Reserve Bank of New York Economic Policy Review
In a relatively brief paper, Alan Auerbach takes on a large task of trying to summarize and draw some conclusions from a quarter century's experience with fiscal policy. With a series of charts and tables, he provides a survey of the major themes in fiscal policy since the early 1970s; but the focus of the paper is on the effort to control the budget deficits that emerged after 1981. Auerbach argues convincingly that the 1981 tax reduction was the dominant event of the period and that it strongly influenced the future direction of both tax and expenditure policies. In my remarks, I would like to extend his theme by trying to ask what has changed as a result of our experience over the past twenty-five years. In that regard, I am most struck by two major innovations. First, in contrast to the late 1960s and early 1970s, fiscal policy has nearly disappeared as a serious tool of short-term stabilization policy. Second, after more than a decade of bitter partisan battles and frequent pronouncements of doom by economists, the budget deficit itself also simply disappeared.
In part, the decline in fiscal policy is simply a reflection of political partisanship that impedes cooperation on economic policy. But beyond the political factors, there are important economic reasons for its fading role. The stature of monetary policy has grown enormously compared with the 1970s. That ascendancy reflects a combination of change in the economic environment in which monetary policy operates, new insights into how to conduct it, and a continuing evolution of the longstanding debate within the profession about the relative effectiveness of monetary and fiscal policy. U.S. monetary policy also emerged in the 1980s with a clear and simple set of policy priorities, something largely absent from fiscal policy.
However, before we write off fiscal policy too quickly as an unneeded redundancy, it is worthwhile to note that the ascendancy of monetary policy has occurred during a period in which the United States was faced with an extraordinary, benevolent economic environment. There have been no unfavorable economic shocks comparable to the energy price increases of the 1970s, and slow growth in the rest of the world has provided the United States with substantial gains in terms of trade. I think we can all agree that the primary credit accruing to the monetary authorities is that they have done nothing at a time when nothing turned out to be the best policy. Regardless, monetary policy has become the primary tool of short-run stabilization, with fiscal policy relegated to a backstopping role. That development has had the added benefit of allowing the focus of fiscal policy to shift toward longer term goals such as promoting economic growth.
Another surprise has been the dramatic reversal of the trend in the fiscal balance within the past few years. For more than a decade, large and growing budget deficits were at the center of any discussion of American budgetary policy. The inability of the Congress and the President to cooperate on a program of deficit reduction was central to the creation of a highly partisan paralysis of the federal government throughout the late 1980s and most of the 1990s. Yet today, the outlook is for a future of large and rising budget surpluses; and most surprising of all, that appears to have occurred without the Congress and the President changing policy in any considerable way.
The magnitude of the revisions to the outlook is highlighted in Chart 1, which shows the progression of the ten-year budget projections, based on current policy, of the Congressional Budget Office (CBO) from 1997 to the present. As recently as early 1996, the outlook was for large and ever-growing deficits that were expected to be about $375 billion by 2005. Today, those same current policy projections show a surplus of $300 billion by 2005, a turnaround of more than 30 percent of government outlays. Those revisions can be divided into three components: legislative actions, changes in the economic projections, and technical reestimates. …