Fiscal Cliff Economics – Part II

Today’s Courier Herald Column:

Yesterday this column dealt with the economics behind the fiscal cliff.  Since no one can get too much of economics lectures disguised as political columns, I’m going to continue that discussion today.

First, a quick review.  We measure our economy’s output – and thus its health – by Gross Domestic Product.  GDP is a calculation of our Consumer Spending (C), Investment (I), Government Spending (G), and Net Exports (X).  You’ll commonly see the basic macroeconomic equation of GDP = C+I+G+X.  It’s very basic math.

More than 2/3 of our economy is Consumer Spending, with that portion representing 71% of the US GDP in 2011.  When consumers get scared, fear losing their jobs, or even fear tax hikes or other expenses on the horizon, they delay their purchases.  It’s a reason why Consumer Confidence surveys are done.  Those with a positive outlook will keep this portion of the economy humming.  Those who are negative can turn a growing GDP into a negative one – indicating a recession – fairly quickly.

Government Spending is next up, at 20% of the US economy.  Stimulus plans are often used to increase economic activity.  It’s easy to see why.  When the difference between 1% of growth in the GDP can make the difference as to whether or not the country is in a recession, government can and often does prime the pump by pushing new spending out the door.

The problem with this method is that it is a temporary fix, and often short lived.  Because our net exports number is negative, (-4%) much of the money that is moved into the hands of consumers has little multiplier effect (meaning the number of times that spending ripples through our economy) because the country that manufacturers our goods gets a lot of the benefit.  Too often, that’s not us.

Furthermore, it is important to distinguish between government spending and transfer payments.  Transfer payments (social security, food stamps, and other programs where the government gives citizens cash directly to spend) do not represent government spending, but are still often pitched as economic stimulus programs.  By definition, they are not.  They take money out of the hands of some (either other consumers in the “C” number or businesses accounted for in the “I” number” and just move money around on the same side of the equation, thus not changing GDP.

This is, of course, unless those transfer payments are paid for using deficit spending, which we covered yesterday.  If the government wants to borrow or print money to cover spending or transfer payments, it can temporarily goose the GDP numbers.  The problem is, again, the effect is often temporary and the residual effect is higher interest payments on government debt.  The effect of these temporary spending binges often ends up borrowing future economic activity to cover today’s needs and later interest payments taking up what would have been economic activity in future years.

Ideally, the way to stimulate an economy is to attract new investment.  This would lead to additional domestic jobs, adding more people to the roles of taxpayers and producing more consumers.  An increase in investment increases both consumption and government spending.  In all the battles currently on Capitol Hill, most are focused on short term political games rather than the long term investment climate of our country.  Investors do not make investments in a climate dominated by short term extensions in search of a grand bargain.

The term “uncertainty” is overused yet simultaneously ignored or misunderstood.  Consumers need certainty to make long term decisions that affect their personal budgets.  Investors need to understand that the rules regarding their tax situations and the myriad of regulations that are often included in these spending bills aren’t going to change every few months.

Both sides of this debate are good at saying “elections have consequences”.  At least one of them, unfortunately, always seems to let that mean “…thus we must wait until the next election so the consequences can go our way.”  This is not how we should govern.

It is time to make long term fixes to our tax code.  We need a viable, long term spending plan on both entitlements and discretionary spending.  The government’s role is to provide this blueprint so that consumers and investors understand the markets in which they will operate, and where to place their bets.

It’s been over 3 years since the Senate has passed a budget.  We’ve been extending “temporary” tax cuts for over two years.  Both parties have made a mockery of certainty, fighting over taxes and spending.  They know that’s what we’re all paying attention to.

All the while, it is the Investment portion of the economy that suffers, because the rules continue to change.  The one part of the economy that could drive to a sustainable economic recovery is the biggest casualty of those battling each other to save this economy exclusively on their own terms.


  1. saltycracker says:

    Great sermon to a believer – now go forth and cast those pearls amongst the unwashed, lurking under gold domed mansions and martyrdom by beer drowning will be yours……

  2. IndyInjun says:

    Investment decisions also require stability in currencies and knowledge that the fires of inflation are not going to be stoked by the Fed into margin-consuming conflagrations. In the 70’s corporations had considerable difficulty in controlling product input costs, with the results that margins were squeezed or destroyed.

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