I'm in the middle of re-reading a book called "Using the Wall Street Journal." I took a wonderful seminar from the book's author, Michael B. Lehman, many, many years ago. The class was, and the book is, a great refresher course for a business economics grad such as myself, that has since forgotten many of the concepts that buttressed my degree of 20 years ago. (In writing this post, I have discovered his blog, Be Your Own Economist, also the title of the course I took from him so long ago.)
I find it strangely comforting to read about the business cycle, the economic cycle that occurs as our economy grows and then contracts. The cycle is fueled by the consumer--as consumers' demand increases, the economy grows. When the consumer puts the breaks on (usually as a result of inflation, either directly, or indirectly as a result of the Fed's action of raising interest rates), our economy contracts. This is normal and inevitable. How long each boom and bust lasts, however is clearly variable.
It's pretty clear that we are in the downward portion of this cycle right now. How much more pain do we have to endure? How long until we begin to recover? That I don't know, but I'm confident the cycle of expansion will resume at some point.
The book is filled with nerdy economics concepts and I'm only a little embarrassed to tell you that I find them FASCINATING. I won't bore you with the entire content, but here's a little quiz I designed from concepts I re-learned today:
Which of the following actions stimulate the economy:
a) tax cuts
b) interest rate cuts
c) increases in government spending
Answer: All of the above.
If you cut taxes, that puts more money in consumers' pockets; they spend it on stuff, and the economy grows. If interest rates go down, that encourages borrowing by consumers and businesses; they take that "money" and spend it on stuff, and the economy grows. If government increases spending, that puts money in consumers' hands (government employees, government contractors, and entitlement recipients); they spend it on stuff, and the economy grows.
Which of the following actions has a dampening effect on the economy:
a) tax increases
b) interest rate increases
c) decreases in government spending
Answer: All of the above.
Conversely, if you raise taxes, that takes money away from consumers; they have less to spend, and the economy slows. If interest rates go up, that discourages borrowing by consumers and businesses; they spend less, and the economy slows. If government decreases spending, that means less money for those government workers and contractors as well as other recipients of government funds; they have less to spend on stuff, and the economy slows.
So remember, when a politician says they want to fix the economy by cutting taxes AND cutting government spending--they didn't pass Econ 101.
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Syd,
Yes and the problem with government spending is that it is relatively inefficient at stimulating today's economy. It reduces the amount of money available for innovation and other better drivers of economic growth. In addition, it takes money out of the hands of consumers, who have been one of the main drivers of economic growth.
I see the challenge as CHOOSING to focus on what best stimulates the economy, not doing everything that could stimulate the economy. If consumer spending is a bigger driver of the economy than government spending (which I think is true today), then cutting taxes and reducing government spending can have a net improvement in the economy.
Posted by: Super Saver | October 17, 2008 at 10:49 AM
The thing is, a consumer is a consumer is a consumer. All their money is green, whether they work in the private sector or whether their employer is the federal government. (Or even, unfortunately, if they borrow the money instead of earning it.)
The economic effect of a dollar spent by the consumer is the same no matter where they got that dollar.
Micheal Lehman addresses this issue in this book. It was John F. Kennedy's team of economists that proposed stimulating consumer demand by cutting taxes rather than stimulating it with government spending:
"The government would still have to borrow to meet the deficit but this time it would do so to pay for a shortfall of revenue rather than a growth in expenditure. One way or the other, demand would grow.
Increased consumer spending was just as good as government spending--and as a rule, politically more advantageous."
Posted by: Retired Syd | October 17, 2008 at 11:17 AM
Syd,
Yes, I fully agree a consumer is a consumer. I was not differentiating between government employees and private sector employees. The difference I noted is between spending by consumers and the government, which is not a consumer. Government spending takes away from producing goods that consumers want.
If increased government spending efficiently stimulated the economy, why hasn't the additional spending on the Iraq war signficantly stimulated the economy?
Posted by: Super Saver | October 17, 2008 at 01:36 PM
As your Economics professor for the day, I'm not here to make a judgement about whether the a's b's or c's are better or worse--just to point out that they have the same stimulative effects or dampening effects on the economy. Here's another pop quiz:
How was demand eventually stimulated so that we finally got out of the Great Depression?
a) Tax cuts
b) Interest rate cuts
c) Government spending
Answer: Government Spending
The government was the "employer of last resort." It didn't matter to the economy whether businesses hired these people or whether the government did. All that mattered was people got jobs and then fueled the economy by spending their paychecks.
The choices among the methods are political choices, not economics.
Posted by: Retired Syd | October 17, 2008 at 03:47 PM