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Economy and Politics
Are you better off now than you
were four years ago
Economy performing poorly,
presidents lose

1960 Nixon, Carter 1980, Bush in 1992
Economy performing well, presidents
win

LBJ 1964, Nixon 1972, Reagan 1984,
Clinton 1996
Important for Congress and
Realignment
Macroeconomic Policy
Fiscal- change tax and spending policy
Monetary- change money supply
Microeconomic policy

Education, labor, technology,
transportation, subsidies to industry etc
Fiscal Policy
Keynes- govt can fine tune the
economy
Recession- Government run
deficits, stimulate demand
Prosperity- run surpluses, cool
economy, prevent inflation
JFK/LBJ tax cut and 1960s boom
Limits of Fiscal
Policy
Political Limitations


love the gas; hate the breaks
slow response time
Economic Limitations
is economy growing or receding?
Erosion of Fiscal Flexibility


The sticky pedal
Anti- tax movement
Budget on Autopilot
Budget Outlook 1995-99, CBO
International
Interest Affairs
13%
1%
Defense
20%
Entitlements
51%
Domestic
15%
Federal Govt Receipts, CBO
Taxes as % of GNP
10
9.18.5
5.9
5
7
4.5
1.5
3.84.9
1.1
3.83.4
1.2
0
Individual
Income
Payroll
Corporate
Income
Other
1950
1970
1990
MONETARISM
#1 tool--raising or lowering
interest rates
Reduce interest rates,
increase supply of money,
people borrow more, economy
grows.
Big advantage– speed
THE FEDERAL RESERVE
SYSTEM
Fed Board of Governors,
Federal Reserve Banks, FOMC
Will Rogers, "there are two
things that can disrupt the
American economy. One is a
war. The other is a meeting
of the Federal Reserve
Board."
Who is this Man?
Interest Rates & the
Fed
Fed recently increased
interest rates
Who made that decision?
Any Guesses?
Insulation for
Politics
Raise their own budget

Bowling alleys on Wall
Street!!!
Appointment process & 14 year
terms
Business confidence in Fed
Monetary policy too arcane
Jawboning
Congressional Hearing on Fed
Greenspan's "We have to bring
the existing instabilities to a
level of stability reasonably
shortly. I think we know where we
have to go. I do not think we
underestimate the severity of the
problems with which we are
dealing,"
Investors-- quarter-point rate
cut is coming
Is independence A Good Idea?
Improves mgmt of economy, fewer
recessions,
Politicians hate to take away the punch
bowl as the party gets going
Odysseus and the Sirens
BANKER DOMINANCE
Fed is Iron Triangle with Bankers
Bankers nominate the Federal Reserve
bank presidents who cast five votes on
the Open Market Committee
Obsession with fighting inflation
People who benefit from low inflation,
are not those who suffer from high
unemployment!!!!!!!!
MONETARISM
#1 tool--raising or lowering
interest rates
Reduce interest rates,
increase supply of money,
people borrow more, economy
grows.
Big advantage– speed
Interest Rates & the
Fed
Fed recently increased
interest rates
Who made that decision?
Any Guesses?
The Maestro
FOMC
Insulation for
Politics
Raise their own budget

Bowling alleys on Wall
Street!!!
Appointment process & 14 year
terms
Business confidence in Fed
Monetary policy too arcane
Minnesota Fed Bank
Jawboning
Congressional Hearing on Fed
Greenspan's "We have to bring
the existing instabilities to a
level of stability reasonably
shortly. I think we know where we
have to go. I do not think we
underestimate the severity of the
problems with which we are
dealing,"
Investors-- quarter-point rate
cut is coming
Is independence A Good Idea?
Improves mgmt of economy, fewer
recessions,
Politicians hate to take away the punch
bowl as the party gets going
Odysseus and the Sirens
Bias of the Fed
Bankers nominate the Federal Reserve
bank presidents who cast five votes on
the Open Market Committee
Obsession with fighting inflation
NAIRU- 6%
People who benefit from low inflation,
are not those who suffer from high
unemployment!!!!!!!!
Political Business Cycle
Pres manipulate economy to engineer
their reelections
Success– Bush and Reagan
Failures– Carter and Bush
Budget Deficits
Major issue in American politics
Solution is simple, cut benefits, raise
taxes
Citizens wants less taxes;
cut spending for welfare, foreign aid,
and space.
Politicians seek seek blame avoidance
techniques
Bracket Creep
Let Inflation work for you!
Auto cuts in benefits and taxes
 Congress never has to raise taxes

End of Bracket Creep

Politicians can no longer avoid taxes
Where do Taxes come from/go?
Taxes- What Economists
Like
broad based taxes
Income tax
 Excise tax
 Sales tax

What elected officials
(and voters) like
Tax preferences/deductions
Good or Bad
Charities, education, local taxes, mortage
interest
 "warfare welfare" $7.6 billion
 "mansion subsidiary" $6.7 billion
 "skybox scandal" $5.5 billion

Problems with preferences
Tax Reform
2 main issues-- the breadth and
progressivity of the tax system
1986 tax reform
 1993 34% upper bracket

Flat Tax
18% for everyone
 Reduce loopholes

Flat Tax--Con
Would hurt charities, home buyers
Would not raise enough money
Main beneficiaries would be wealthy
$24,650 taxed at a 15 percent rate
 $50,000 taxed at 28% rate
 $1 million taxed at 36% rate

Flat Tax- pro
Why penalize hard work, investment
Simplicity
Internet world
Already have a flat tax-- Social
insurance taxes