The FED's fiscal policy

  • 67
  • 0
Unlike the FED’s monetary policy, we are going to study the FED’s fiscal policy in a generic way, as its effects are mechanically comparable regardless of the legislation.

The budget can only be presented in three forms:



- a balanced budget
- a deficit budget
- a surplus budget

We are going to look at the consequences of these different presentations on the economy and therefore on the markets.

A BALANCED BUDGET AND ITS CONSEQUENCES



All other things being equal, this is, theoretically, the simplest situation.
Overall there is neither monetary creation nor destruction: with this choice the political power maintains the equilibrium/disequilibrium. The only consequences are the relative weight of public debt compared to GDP and the burden of debt on the State budget.

Several hypotheses lead to the establishment of such a budget:
- satisfactory situation: balances are maintained, attempts are made to prolong the trend
- the lesser of two evils: attempts are made to avoid accentuating the latent imbalances in the economy, while waiting for better days.

The financial markets' interpretation of these situations are obviously not the same.
In the first case, the response is probably positive (no negative reactions with foreign exchange, interest rate and equity markets.)
In the second case, the markets swing between the positive (still in equilibrium) and negative (no improvement.)
The consequences are measured on a case-by-case and market-by-market basis.

A DEFICIT BUDGET AND ITS CONSEQUENCES



Taking up Keynesian theory again, this budget looks like a stimulus budget. However, a distinction has to be made between a voluntary budget and an endemic situation reflecting the State's inability to contain its expenditure.
In both cases the gross consequences are the same, but the difference is made by the financial markets:
If monetary creation automatically leads to an increase in interest rates, inflation, unfair competition in the long-term market between the State and the private sector, weakening of national currency futures, and if the situation persists in terms of difficulties for this country to find resources, the markets differentiate between the following two cases:
- the case of the voluntary budget: the markets may be ready to accept it under certain conditions (exceptional case, use of a homeopathic dose deficit, rating compatible with cumulative deficits, etc.)
- in the second case, the markets will not be ready to accept such a situation and amplify the disequilibrium, which can bring paroxysm and can lead to real crisis (Russia 1998) or latent(Turkey, Argentina today)situations.

A SURPLUS BUDGET AND ITS CONSEQUENCES



This ideal situation allows the political power to make real choices.

What to do with the surplus?

- repay part of the public debt
- develop social programs
- engage in a public investment policy
- reduce the tax burden
- use these surpluses in the case of an unforeseeable event
All these choices will have very different consequences both immediate and long term

1/ IMMEDIATE CONSEQUENCES:



* Public debt repayment:
- reduction of "long-term" rates
- less private/public competition in fundraising
- debt relief

*Development of social programs:
- none

*Public investment policy
- job creation

* Tax relief
- increase in consumption

* Use of surpluses in the event of exceptional events
- this is the case in the USA after 11/09/2001. The government with large tax buffers can decide on relief to both directly cover losses ($40M for airlines and insurance and reinsurance companies) and boost consumption ($100M in tax relief for households)

2/ LONG TERM CONSEQUENCES



All these consequences have to be measured with a constant perimeter (all other things being equal)

* Public debt repayment
- lower taxes leading to an increase in disposable income (which is divided between consumption and savings.)

* Development of social programs
- more room for the welfare state and increased household disposable income

*Tax relief
- the consequences depend on the nature of the tax reduction; if it is a reduction in direct tax (in the case of the USA), in the long term the increase in consumption leads to an increase in indirect tax revenues; if it is a reduction in the tax base there are no long term consequences.

*Use of surpluses for exceptional cases
- the long term consequences depend both on the seriousness of the events and on the political choices made to correct this situation.

About author

  • 5
  • 21
  • 40
  • 0

Add a comment

no pic

Comments

0 Comments