Monday, December 29, 2008
Slippery Slope of Fiscal Policy
An increase in government spending increases the trade deficit and leads to a depreciation of the dollar. Government spending in excess of tax revenues means a growing budget deficit. Paul Krugman estimates the multiplier effect of the $700 billion package at 1.1. Of course, crowding out is a problem. See Wade Rousse for an excellent discussion on government spending. Also, fiscal policy suffers from lags and bad timing. Greg Mankiw reiterates what colleague, David Backus writes, “It’s the financial system, stupid” implying that the fiscal policy is misdirected. Fiscal policy is a slippery slope. I will aver that when the government intervenes, more is lost than is gained.