Macroeconomics: The Effects of The Politics on Fiscal Policy over The Last Seven Business Cycles

MACROECONOMICS: The Effects of the Politics on Fiscal Policy over the Last Seven Business Cycles

Jennifer Johns

Principles of Macroeconomics

Dr. Jean-Rony Lafalaise, DPA

April 22, 2004

Abstract

Being an election year, all you hear is the incoming presidential nominee bashing the policies of the current president. Of all of the administration policy, his economic stance, the health of the economy under his administration, and this fiscal policy are among the most prevalent. Does the possibility of losing an election affect how administration reacts to a recession? This paper shows that out of the last seven business cycles, during the last five politics does not seem to be an issue when administrations consider what needs to be done to boost the economy. Though Kennedy and Nixon both tried to use fiscal policy to further their own position and ensure reelection, the administration of late have understood that the economy is not a reelection tool and that what ever need to be done to bring us out of a recession is necessary, even if it means they may risk not getting reelected.

MACROECONOMICS: The Effects of the Politics on Fiscal Policy over the Last Seven Business Cycles

Reelection be Damned

One might wonder how politics plays into fiscal policy. Does the possibility of not getting reelected affect the choices a president makes? No, in fact, the administrations of the last seven business cycles usually make fiscal policy decisions that prove to be political suicide, yet are best for the economy. Started with the farthest back, John F. Kennedy is an exception to this rule. In his campaign, he promised tax cuts, but by the time congress got around to it, the economy was obviously expanding. Seeing as this would be embarrassing to the administration, congress went ahead and approved the unnecessary tax cut. Richard Nixon, whose reelection was a non issue due to his resignation, also played the political game. Though his administration say that wage/price control would be ineffective at controlling inflation, they went ahead and implemented them with the goal of "gently tighten monetary and fiscal policy, which they thought would bring down inflation without a big increase in unemployment" (Hebert, 1984, 4). This proved to be detrimental anyway because wile people expected prices to stabilize, they failed to realize that this meant that the prices they charged would stop rising as well. Ronald Reagan took a huge leap of faith when his administration introduced supply-side economics. Although it didn't work in the way that he wanted it to, it helped greatly to boost the economy. However, had it been a horrible flop, His administration would have been highly chastised for it. He ended up losing the election largely because in trying to stabilize the economy and control inflation, the national deficit grew considerably. George Bush Sr. had much of the same problem. As previously stated, Bush refused to use fiscal policy to control the economy, as he knew it may in fact "hamper the economy's recovery" (Walsh, 2002, 3). Bush's competition of reelection attacked his lack of use of fiscal policy, and was a key component to him losing the election. Bill Clinton actually raised taxes. His economic success came mainly though the control of the monetary policy and the actions of the Federal Reserve. The Fed worried about the stabilization of the economy, while Clinton worked on the deficit and budget with great success. This was risky however because had something gone wrong, Clinton's raise in taxes and lack of fiscal policy would have come into question and he would not have been reelected in 1996. As far as I can tell, Bush does not seem to be as concerned with getting reelected as he does turning the economy around. Luckily, the tax cuts and rebates he campaigned with actually helped to cushion the blow of the recession, and since the trough, the Federal Reserve have pretty much been given the reigns of the economy. Though he is being attacked for his lack of policy since the trough and for his economic practices, he has done what he believed he must to expand the economy.

MACROECONOMICS: The Effects of the Politics on Fiscal Policy over the Last Seven Business Cycles

Review of Literature

The oldest of the last seven business cycles peaked in April of 1960 . During this time, unemployment was at 5.3 percent , and inflation reached .442 . Ten months later, the business cycle hit its trough in February of 1961. The unemployment rate rose to 6.9 percent, while inflations dropped to 0. Dwight Eisenhower was reaching the end of his presidency in 1961, but was in office for both the peak and the trough of the business cycle. By November, he was out and the beloved John F. Kennedy had taken office. By this time, the business cycle had started to expand and unemployment had already dropped to 6.7 percent. According to Herbert Stein's piece entitled "Why JFK Cut Taxes" in The Wall Street Journal, Kennedy's administration wanted to boost the economy by "easing monetary policy" (Stein, 1996, 10). Of course, they could not control the monetary policy which was tied up in balance-of-payment deficit and supporting the U.S. dollar exchange rate. Fearing another recession, the JFK administration wanted to restore confidence by implementing a tax cut. However, they did not plan on cutting government spending to counteract the tax cut. Congress insisted in "expenditure restraints" (Stein, 1996, 12). With the tax cut came extended economic expansion. However, these facts seem to be more correlation then causation. Expansion began in February of 1961 well before the tax cut was implemented in the middle of 1963. As a matter of fact it became so obvious that that economic recovery was underway that some wondered if the tax cut was still necessary. But, seeing as it would be a huge imbarrisment to the Kennedy administration, congress went ahead and approved the tax cut. In actuality, monetary policy was more of a saving grace in the 1961 recession then fiscal policy. From 1959 to 1962 the Federal Reserve "increased [the money supply, M1] at an annual rate of 1.8%" (Stein, 1996, 13).

Then U.S. economy continued to grow