Fiscal policy has a positive effect on economic growth and is needed as a way to escape from a recession. The Fed expanded the money supply to make up for political restraints put on the economic-stimulus effort. Political considerations have trumped pro-growth economic policies in this post-recession environment.
Janet Yellen, the new chairwoman of the Federal Reserve Banking system (Fed)--she replaces Ben Bernanke, said the Fed will taper quantitative easing (QE) or bond-buying activities by $10 billion a month during the first quarter of 2014 and contemplates ending the program later this year. The Fed will also stop focusing on the unemployment (it is 6.7 percent currently) rate as a goal of Fed policy. This does not represent a major change in policy from her predecessor's, who indicated he was planning to go down that road, too. This is significant because QE was part of a two-pronged effort: (1) fiscal policy, namely, stimulus, and (2) monetary policy, that is, low interest rates; both were intended to fight the 2008 Great Recession.
The White House tried fiscal policy through stimulus--The American Recovery and Reinvestment Act ($787 billion in 2009)--to increase aggregate spending in the economy due to the unwillingness of businesses to spend (on investment) because demand for goods and services had declined. However, stimulus faced several head winds--resistance by Congress and by some state governors. For example, Florida turned down two billions dollars for a Tampa-Orlando high-speed rail network that would have created jobs; the state also turned away money for Medicaid expansion for about 1.2 million Floridians. New Jersey rejected three billions federal dollars for a New York/New Jersey tunnel. If you didn't know better, you'd think these actions were calculated attempts to keep the economy in the tank for political reasons. Fiscal policy--namely, increases in government spending--is the right strategy for an economy struggling with people having no money to spend on consumer goods and business (flushed with funds) but showing no desire to allocate financial resources to new investment. I have made this argument consistently, i.e. that the economy would have experienced a robust recovery were it not for the political gamesmanship taking place in Washington.
Recently, Fed Chairwoman Janet Yellen made the point: " ... we have had a good deal of fiscal consolidation in the United States ... and ... at a time when fiscal policy normally in the past would have been serving to create jobs. Fiscal policy from that standpoint has served as a headwind to the recovery and especially at the federal but at the state and local level as well ... we've had a disappointing recovery. Monetary policy ... has tried to offset that ..." And this is why the Fed has been flooding the economy with money while ignoring the long-term consequences of such a policy for inflation and exchange rates. A side effect of the Fed's policy of increasing the money supply has been to keep interest rates low, which hurt people who depend on interest income to supplement their retirement benefits. However, the policy has been very good for banks because they can pay you a pittance for your deposits and the turn around and charge you exorbitant rate of interest on a loan. Remember, banks and Wall Street were responsible, in large measure, for the 2008 recession, but the federal government decided to bail out the perpetrators of this major economic debacle.
Despite Janet Yellen's assertions about the purpose of fiscal policy, some elected members of Congress (and some economists) pooh-poohed the positive effects of fiscal policy. In the United States, it is difficult for fiscal policy to get traction--when the economy is on a downward spiral and the private sector is deleveraging--fiscal hawks stymied the stimulus every time leading to this weak economic recovery. According to The Economist, Greg Mankiw explains why fiscal policy does not work in the U.S.: "A country generally skeptical of stimulus, ... will reach for it [stimulus] in an emergency [such as the Great Recession of 2008] and find that it is unprepared. Automatic stabilisers will be too small and will require constant Congressional maintenance. Too few projects will be shovel-ready. The need to legislate will lead to inclusion of pork items that aren't particularly stimulative. Stimulus will be less targeted, timely, and effective as a result." The less-effective results of stimulus cause deficit hawks to proclaim stimulus--which they trimmed initially from $1 trillion to about $787 billion--does not work. So recently Speaker of the House John Boehner even asked: "Where are the jobs?" Further, ignoring the role of Congress in what happens to the economy, Speaker Boehner stated, "Far too many Americans are still unemployed in President Obama's economy."
Ironically, the deficit hawks have been very effective at putting their foot on the brakes of economic growth with the consequence that people--victims--suffer. The victims of the political machinations played out in Washington are the millions of unemployed Americans--including the ones who are long-term unemployed and their families--retirees whose 401(k) underperformed, the multitude of foreclosed mortgages, sequestration-induced furloughs, and so forth. All these things are connected because a poorly performing economy spikes the deficit--because government revenues fall while government spending rises--and this leads to conflicts over raising the debt ceiling, and government shutdowns.
In the politically driven environment of Washington, data--evidence, scientific and otherwise--are ignored and often replaced by political consideration for party or personal gains in lieu of widespread economic benefits. You'd think patriotism is made of sterner stuff.
Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in Botswana in 1991 and the most recent in Ethiopia in 2009. He was on the Truman State University faculty until 2008.