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Economist Christine Romer on fiscal policy

From an interview (along with her husband David Romer) in a Federal Reserve Bank of Minneapolis publication, the Region:

"What's very striking is that we had a pretty sensible long-run fiscal view in the 1950s - the budget should be balanced over the medium run, but not each and every year and not in exceptional circumstances ....

"But views took an unfortunate turn in the 1960s and 70s. Policymakers started to believe that budget balance was not important even over an extended horizon, and that tax cuts would pay for themselves. And views took another wrong turn in the 1980s, when policymakers added notions such as the starve-the-beast hypothesis that tax cuts would force spending cuts. I think these are wrong turns that we haven't corrected yet - as evidenced by our ever-worsening long-term fiscal outlook."

The Romers' empirical work has refuted the starve-the-beast hypothesis as applied to the last few decades, and showed instead that what tax cuts lead to is subsequent tax increases. (I've also seen empirical work suggesting that tax cuts tend to be accompanied by spending increases, since fiscal discipline is either tight or slack - although here the theory is correlation with an underlying common cause, not necessarily direct causation).

Astonishing historical factoid from the Romer interview: taxes were apparently raised at the beginning of the Korean War BEFORE significant money was actually being spent on it, simply because they knew that the high expenditure levels were coming. That is like hearing tidings from another planet, inhabited by a farsighted species entirely unlike our own.

Full post as published by Start Making Sense on November 02, 2008 (boomark / email).