January 13, 2003
Steve Cecchetti on Frameworks for Fiscal Policy

David Warsh's online "Economic Principals" has a nice summary of Steve Cecchetti's ideas for a Framework for Fiscal Policy. I think his particular framework is a bad idea: the existence of the baby-boom generation, rising medical costs, and the belief that everyone ought to be able to see a doctor together more-or-less force federal government spending up from its current twenty percent or so of GDP to somewhere between twenty-five and thirty percent over the next generation. Cecchetti's belief that taxes should be restricted to 19 percent of GDP and debt to 50 percent is a decision to award victory to one side of American politics in a debate that has yet to be started.

But the broader point that fiscal policy has been a total botch and that major plans for reform are desperately needed is completely correct.

Ideas, anyone?

Economic Principals: ...The government needs a comprehensive new fiscal policy framework, comparable to inflation targeting, [Steve] Cecchetti argued. "Early attempts have misfired," he wrote, "but it is important that we redouble or efforts now."

The idea that the government should estimate the net-present-value of its unfunded obligations over a 75-year or so horizon is hardly new, as Cecchetti acknowledged. Fed chairman Alan Greenspan plumped for accrual-based accounting in Congressional hearings last year. The same sort of reasoning underlay the now-lapsed Budget Enforcement Act. Yet legislatorsí temptation to avoid estimating price tags for benefit programs is very great. It is roughly comparable to central bankersí tendency to use easy money to purchase fast growth and political advantage during the high-inflation years.

"We need to achieve fiscal discipline that ties fiscal policy-makersí hands, just as a price stability objectives tie the hands of monetary policy makers," wrote Cecchett, drawing an analogy with the extensive investigation of commitment in monetary policy of the last twenty years.

To get things started, he wrote, "We should restrict federal government revenues to the 40-year average of 19 percent of GDP and estimated public debt should not rise above 50 percent of GDP. All current and future tax or spending proposals should be evaluated relative to this objective."

Cecchetti is a specialist in monetary policy. He has taught economics at Ohio State University before and after he ran the research department for the New York Fed. Next autumn he will move to Brandeis.

Posted by DeLong at January 13, 2003 01:42 PM | Trackback

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Why do we consider medical costs such a problem?

Suppose we choose to keep increasing spending on medical care because we value our health or appearance so highly? Health and appearance are after all prime sources of satisfaction. When does "too much" health care spending begin?

Thailand is offering health care services for Asian tourists and is building a fine "export" market for the services. Brazil can afford to pay for AIDS medicines for all. I suggest that such health care spending by Brazil is a major economic benefit for the populace as a whole. Why should we worry so about health care spending?

Posted by: on January 13, 2003 02:02 PM

By the way -- We live in a region that has been largely cushioned from the economic weakness of the past 2 years by the strength of the health care industry.

Posted by: on January 13, 2003 02:06 PM

Oddly enough, kausfiles had an item a few months ago making passing reference to a Fiscal Fed, an independent board that would make fiscal decisions much the way the Fed makes monetary decisions now.

Kaus didn't flesh the idea out at all, and in fact rather disparaged it, but it sounds like a smashing one to me. At the very least it would end "Santa Claus" government: no new programs without tax increases, no tax cuts without program cuts.

Posted by: son volt on January 13, 2003 02:09 PM

There is concern in South Africa that excessive spending on AIDS medicines may be an economic problem. Of course, I believe we need to assist South Africa. But, I wonder why South Africa could not benefit by developing a generic drug industry as have Brazil and India and Thailand and producing generics to help meet the dire emergency. Setting aside the fight over patent rights, I think South Africa would find huge benefit in development of a drug industry.

Posted by: on January 13, 2003 02:13 PM

There would be more constrains on fiscal policy if the Fed was more independent and refused to liquidify when the governement turns fiscally incontinent. The hope would be that knowing this ex-ante the government would have an incentive to be fiscaly responsible. One could imagine that governments would also learn that deficit spending has to be effective, otherwise they'd be trashing the economy and their political careers.

The problem is that we simply don't live in that kind of world, besides the fact that this kind of commitment could turn out to be catastrophic under (not-so-)extraordinary circumstances... A more realistic but certainly fuzzier proposition would consist in economists working harder at educating the electorate about the importance of fiscal restraint especially when facing unprecedenced unfunded claims that are essential to the well-being of large sectors of the population.

Posted by: Jean-Philippe Stijns on January 13, 2003 02:14 PM

Circumventing the political process in fiscal decisions would be to give over being a democracy.

Posted by: on January 13, 2003 02:16 PM

Aggreed. But what if elected politicians have an incentive to cheat democracy for near-sighted populist / electoral purposes, regardless of their campain promises? Changing the constitution is a very difficult process for the same kind of reasons. There is a degree of similarity with fiscal discipline: governments shouldn't be allowed to borrow on future citizens (and governments) to improve their political prospects with current voters. Of course, none of this would be a concern if the average voter was more economics-litterate and less prone to hyperbolic discounting...

Posted by: Jean-Philippe Stijns on January 13, 2003 02:28 PM

Circumventing the political process in fiscal decisions would be to give over being a democracy.

Kaus didn't provide any details, but I envision Congress saying "who pays", i.e., would still set the tax brackets. And Congress could enact in advance how any future tax increases or cuts would be distributed. So the Fiscal Fed would only determine how much is financed with taxes, and how much is financed with borrowing.

Better still, the debt ceiling alone could be set by the Fiscal Fed (in advance or based on what spending was approved), and the rest would still be left to Congress.

Posted by: son volt on January 13, 2003 02:41 PM

The problem with cash accounting rather than accrual accounting is that it enables politicians to wait until crisis strikes before taking action. As presently constituted Medicare and Social Security are ticking financial time bombs; fortunately, the fix is very easy once the country faces up to the problem. Of course, I'm not holding my breath on the "facing up" timeframe.

How to fix Medicare and Social Security? First, gradually raise the qualifying age from 65 up to something more in line with the improving health of elder Americans. Bismark screwed up when he created the first social security net because he didn't realize the mean and median age would rise so far so fast. (The U.S. borrowed the age of 65 from Bismark when we created our Social Security program). Just gradually raising the qualifying age for Social Security and Medicare is a huge money saver.

Along with the first part, change the tax code so that people collecting Social Security aren't penalized for working - in fact, change the tax code so that people collecting Social Security are incentivized (a little) TO WORK.

Third, announce the changes NOW so that people can plan their lives intelligently

Posted by: Anarchus on January 13, 2003 03:11 PM

I agree with Brad that policy should be based on something more than just accounting rules.

The problem is that health care spending on people over the age of 65 is going to rise dramatically, and if you keep that in the public sector then we need more government spending, which means more taxes, which if nothing else means more deadweight loss.

My alternative is here: http://www.techcentralstation.com/1051/techwrapper.jsp?PID=1051-250&CID=1051-121602A

Posted by: Arnold Kling on January 14, 2003 06:03 AM

Shouldn't that be "Economic Principles?" Or is there some kind of wordplay going on I'm missing?

Posted by: Bernard Yomtov on January 14, 2003 10:08 AM
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