10 - Fear of deficit financing – is it rational?

Summary

Introduction

A sine qua non for successful international cooperation to combat the spread of infectious diseases proved to be emergence of a scientific consensus on the way they are transmitted; and, by analogy, Richard Cooper has argued that broad agreement on the likely effects of fiscal and monetary actions is an essential prerequisite for the effective coordination of macroeconomic policy. The omens, however, are none too promising.

On the one hand, Bryant, Helliwell and Hooper conclude their survey of the consequences of changes in US fiscal policy (as revealed by simulation of several global macroeconomic models) with observations that seem consistent with a conventional Keynesian approach; at least for the short run. In their words: ‘An unanticipated cut in U.S. federal purchases could have a substantial negative impact on the level of U.S. real output for several years, … and to a lesser but still significant extent on output outside the United States’; though they go on to observe that: ‘the declines in U.S. prices, interest rates and the dollar would eventually stimulate domestic demand and net exports enough to reverse most of the decline in output within five or six years’ (Bryant et al., 1989, p. 101).

On the other hand, some economists argue that changes in federal spending have contrary effects on GNP. Fels and Froehlich, for example, not that an ‘anti-Keynesian’ policy of fiscal consolidation in the Federal Republic of Germany coincided with a rapid recovery of the economy from the 1981–82 recession, and attribute this ‘coincidence’ in large part to the benign effect of fiscal consolidation on expectations in the private sector.