In a comment below, Jamie Galbraith refers to a paper he co-wrote that links the Fed's interest rate decisions to the election cycle -- Until we can fix the link, it can be found at:  http://utip.gov.utexas.edu/papers/utip_42.pdf.

The budget process is in dire trouble.  Turning matters over to a “Budget Fed” would be the worst of all possible cures.

Professor Leeper’s ideas about transparency are beyond ludicrous.  In the United States, fiscal policy is almost wholly transparent. You can follow the process every day as the budget goes through Congress.  Projections abound.  They are usually wrong, but this is not because of “politics” or secret scheming.  It’s because the models on which they are based contain grossly unrealistic assumptions (such as the Natural Rate of Unemployment, an economists’ favorite). And because the politicians have never grasped the basic accounting relationships that link the US economy to the rest of the world.

Yes, monetary policy is more transparent than it once was.  But why? The only reason is that Congress has worked hard, over decades, to crack the unnecessary secrecy of the central bank. Milestones in this struggle were the passage of H.Con. Res. 133 in 1975 and the Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978, which together established today’s monetary policy reporting procedures. Chairman Henry Reuss did this work. (As Reuss’s economist on the Banking Committee staff, I drafted the provisions of the H-H act on monetary reporting and supervised the hearings.)  In later years, Chairman Henry Gonzales carried on the fight against compulsive Fed secrecy, and today a champion of this bipartisan effort is Representative Ron Paul.

Still, even today, the Federal Open Market Committee meets in secret – a privilege most congressional committees forewent decades back.

How could Congress achieve this? Only because -- contrary to a lot of muddled thinking among economists -- the Federal Reserve is not an independent branch of government. It is independent only of the executive branch.  It is a statutory agency, subject to Congressional mandate and oversight, epitomized by the semi-annual hearings.  The Fed makes no similar reports to the President.  

Is the Fed, for all that, truly independent of politics? An impolite question. Yet, a statistical analysis of the yield curve– found at  suggests otherwise.  We found that there is a systematic, strong, and robust  tendency for the Fed to ease in years when Republican administrations face re-election, and to tighten in years when Democrats are up.  Note that former Republican Chairs of the Council of Economic Advisers (Arthur Burns, Alan Greenspan and Ben Bernanke) have largely held the Fed chair since the 1960s. Burns and Greenspan, at least, were both highly partisan.  So this is perhaps not surprising – except to people who think politics stops on Constitution Avenue.

Today’s budget process began with the 1974 Budget and Impoundment Control Act. The Bretton Woods world of fixed exchange rates had only just been dismantled. The United States still lived in a world of dollar stability and a near-balanced current account.  Given the accounting relationships, it was reasonable to think in terms of a stable positive net private savings rate and a near-balanced federal budget.

The rise of flexible exchange rates and the dollar-reserve system destroyed the economic possibility of such balance. So long as the world wants to store dollars – for whatever reason – the US will run a current account deficit equal, to the penny, to that desire. There will be a corresponding internal deficit – public and private. When, as at present, private households are net savers (net, because investment has collapsed more than saving), the public budget must and will be in deficit, big-time. There is nothing that any budget process can do about this.

A budget process focused on deficit reduction and aiming toward a balanced budget is therefore illusory, both in general and especially in a crisis. It is doomed to repetitive failure and disappointment, because the goal is not only meaningless and unrealistic, but actively undesirable.  Budget balance can only be achieved through a bubble – a big private deficit, inevitably temporary, as in the late 1990s – or a collapse of the dollar.  Placing such a process outside congressional control would not make it realistic.

As a detail, removing fiscal policy from Congress would be unconstitutional. The Constitution -- Article I, Section 8   --  gives the power to authorize and appropriate funds and to impose taxes to Congress. And only to Congress. Congress can – and does – already delegate much of actual budget-making to executive agencies, and a lot of details to CBO and its own staff. But it cannot escape responsibility for authorizations,  appropriations, and taxes, without changing our system into a technocrats’ dictatorship. Professor Leeper’s proposal comes quite close to that.

The way forward?  It is not to dream up crazy new institutions.  It is not to tie up the government with crazy rules. (Instead, we should consider scrapping the dysfunctional rules we have.)   The way forward is to keep an eye on ultimate objectives: full employment, balanced growth, reasonable price stability.  The Humphrey-Hawkins law got that right, long ago. 

Collapse

Eric Leeper’s paper makes a compelling argument for transparent and predictable fiscal policy based on the overwhelming acceptance—and success—of such standards for monetary policy.  Even more importantly, given that our current political system seems utterly incapable of recognizing fiscal constraints, adult supervision from a nonpolitical body seems very appealing and may be the only option to avoid fiscal disaster.

That said, there are big challenges in designing an effective mechanism to credibly commit to a course of fiscal policy (as Eric acknowledges in his article).  An independent Fiscal Fed would appear to raise legal issues since the constitution vests power to levy taxes solely with Congress.  The Fiscal Fed could set deficit targets, but Congress would have to implement them.  One approach in the spirit of Leeper’s proposal is the bipartisan entitlement reform commission proposed by Senators Kent Conrad (D-ND) and Judd Gregg (R-NH), modeled after the Base Realignment and Closure Commission, that would present Congress with a set of proposals that would be subject to an up or down vote with no amendments.

The problem with such proposals is that the same kinds of political pressures that prevent Congress from making hard choices would also affect any bipartisan commission.  A truly independent Fiscal Fed could make the hard choices, but Congress and the President have shown again and again their ability to skirt or weaken rules that they find inconvenient.  (See, e.g., PAYGO and budget process.)

For example, states have annual balanced budget requirements, which would seem to require an extreme form of fiscal restraint, but they routinely find ways around budget limits.  Some just borrow in ways that are legally permissible, even if in flagrant violation of the spirit of balanced budget limits. State and local governments often hide borrowing in the form of unfunded commitments for employee pensions and retiree health benefits.  Besides for illustrating the endless ability of politicians to get around inconvenient rules, these tricks also show that getting the federal budget under control will not guarantee government finances will be transparent and predictable, unless state and local governments could also be brought under the control of the new regime, which isn’t going to happen.

I don’t think that a truly independent fiscal authority is legally or politically feasible, but it’s a very intriguing idea. If somehow all the constitutional and political hurdles could be surmounted, the Fiscal Fed would need an instrument of fiscal policy, as Alan Auerbach notes.  One possibility would be to create a national value-added tax (VAT) with the rate and base under the control of the independent fiscal authority.  The Fiscal Fed could vary VAT rates to help stabilize the economy in the short run (presumably in consultation with the real Fed).  The UK has cut its VAT rate as a way to boost consumer spending, so this is not a completely revolutionary proposal.  The Fiscal Fed could also adjust the VAT rate to meet long-term fiscal targets. If current policies continued, this could eventually require extremely high rates, but that would presumably put pressure on policy makers to find other more palatable ways to control spending or raise revenues.

Collapse

What we need is an AAWP, W for working, and an AAYP, Y for young, to go along with the AARP, formerly known as the American Association of Retired People.  Until the next generation of Americans can find some way of expressing themselves politically, this discussion about an independent fiscal policy is naively academic.  This applies to all levels of governance.  Close to home, the pension system of the University of California is now seriously underfunded, and will require the tax we call “contributions to retirement” on future UC Professors to fund my lavish retirement made possible by a defined benefit plan.  Thank you very much. 

Sometimes it takes inappropriate language with some serious affect to get you to hear the message.  Young Americans:  You are getting screwed!

This question basically comes back to whether the representative democracy system that the U.S. has would make better fiscal policy than a panel of fiscal policy experts, better as defined by which produces a higher social well-being broadly defined. (By broadly defined, I mean including not just maximizing consumer surplus plus producer surplus but also including concerns for distributional outcomes, infringements on liberty/fairness, etc.)

I see two possible overarching problems with the current system: (1) policymakers are subverted by asymmetric special interests that can tilt policies in one direction that fall well short of maximizing social well-being (ex: subsidies for housing that far exceed any positive externality justification); and/or (2) policymakers reflect the will of the voters on fiscal policy, but the voters have beliefs on policy matters that aren't in society's interests (ex: support for command-and-control policies on fuel mileage as opposed to just a simple carbon tax).

The first is the classic Buchanan/Tullock/Stigler critique of rent-seeking in government that exists due to the problem of diffuse costs/concentrated benefits. The second is the Caplan critique that says voters often get what they want on economic policy, and that's a problem.

Collapse

Given the success of independent monetary authorities, it is logical to ask whether such independence should be extended to fiscal policy. Here, it is important to draw a distinction between independent evaluations of fiscal policy and policy independence itself.

Having an official and yet independent entity that evaluates the fiscal performance of the government, makes projections of the consequences of current fiscal policy, and evaluates alternative policy paths would be all to the good. Whether this might take the form of an evolved and more independent Congressional Budget Office or a new agency is an open question. Forcing the government to respond publicly to periodic evaluations by such an agency would inject more reality into the fiscal policy process and keep the Emperor’s new clothes in the closet. The recently created fiscal policy council in Sweden offers one illustration of how this might work.

But some would go much further, ceding to such an agency the power to set fiscal variables, much as the Fed sets the Federal Funds rate. Here, the task becomes much more difficult. If the policy variable is to be a deficit target, should the deficit include accruing implicit liabilities? If it is a spending target, would tax expenditures be included? What about regulations that mimic the role of fiscal policies? Before this second step is seriously contemplated, these questions and many others will require satisfactory answers.

Collapse