Fiscal Policy and Economic Growth: So, Who's Right About Fiscal Policy?

So, Who's Right About Fiscal Policy?

Did the tax cut of 1981 lead to the deficits of the 1980s and the need to raise taxes in 1990 and 1993? Did the 1981 tax cut also lead to the expansion of the 1980s? Did the tax increases of 1990 and 1993 help bring about the 1990s expansion?

For what it's worth, I believe the answer to all three questions is yes. But a) I have no political ax to grind, and b) I believe that other factors helped both recoveries, which together actually amount to one, long, nearly 20-year expansion. The period from 1982 to 2000 was a long boom interrupted by a recession in 1991.

By “other factors” I mean the natural business cycle and long-term population trends. These may be the most important factors of all. After the depressed demand of the 1970s, the economy was poised for expansion due to “pent-up demand.” The early 1970's tripling of gasoline prices had to be absorbed into the economy. That happened in the 1970s, a time of lackluster growth. In the 1980s, that pent-up demand was released.

In addition, baby boomers had to find employment, get married, buy condos and houses and furniture and appliances, start purchasing new cars, have children, go to Disney World, get divorced and remarried, buy computers and software, join health clubs, get hair transplants, and generally make their contribution to production and consumption. That they did, and it may well be the single largest factor driving the 20-year boom.

However, a business cycle and population-driven boom gives neither political party credit for economic genius. In truth, each major party has its share of good and bad economic policy prescriptions. (I say “major parties” because the flat tax, the Libertarian Party's idea of the federal government paying only for defense, and most economic notions of the Green Party are all too far-fetched for the United States.) Also, as I've noted, the hurly-burly of politics is a better place than most to thrash out the economic questions facing U.S. society.

Fortunately for all of us, there is a less politically charged and equally useful tool for keeping the economy on a long-term, low-inflation, low-unemployment growth trajectory. That would be monetary policy.