Fiscal Policy in Macro Theory: A Survey and Evaluation

Abstract

The momentum of academic discussions substantially changed in retrospect the range of issues surrounding fiscal policy. The analytic evolutions and the resulting discussions modified many questions and emphasized new dimensions. Academic discussions were also influenced in recent years by political events and discussions in the public arena. The emergence of a comparatively large and possibly “permanent” deficit in the Federal budget motivated another round of discussions. There appeared voices claiming that such deficits produce, in contrast to Keynesian arguments, negative short-run effects on output. Others emphasized the long-run effects on normal growth. Many concentrated on linking high interest rates with the prevailing large deficit. The inflationary significance of the deficit was also considered. Some arguments seem to recognize a direct link between deficits and inflation. More carefully developed arguments emphasize the longer-run effect of persistent deficits on monetary policy. It would appear that an anti-inflationary policy pur sued in the context of a permanent deficit cannot persist. Fiscal policy appears under the circumstances as the longer-run determinant of monetary policy and a crucial characteristic of the ultimately prevailing mone tary regime. It follows that no reliable change in monetary regime is really feasible without an associated change in the long-run fiscal regime. This argument introduced a new focus and attention to fiscal policy. The evolution of questions, issues, and analysis over the past nineteen years since the “war between the radio stations” (FM, AM, DM) in the American Economic Review (1965) justified in the judgment of the Confer ence organizers, and also in my judgment, an appraisal of our intellectual positions. My paper is addressed to this task. It offers essentially a survey over major strands of the discussion evolving over the past twenty years. This survey remains somewhat selective even within its confined range of macroeconomic issues. Neither does it cultivate a “neutral” account. It involves interpretations and evaluations referring to aspects of arguments advanced or to dimensions of the analysis that require more attention. The first section covers the fiscalist—monetarist debate of the late sixties and early seventies. It evaluates the empirical work bearing on the central questions addressed at the time. The following section attends to the range of issues raised by the neoclassical cum rational expectations approach. Section 4 examines a number of problems recently associated with transitory and permanent deficits. The last section assesses the consequences of our intellectual position with respect to fiscal policy making and the choice of fiscal regime.