Wednesday, October 6, 2010

The Continuing Resolution: Fiscal Alchemy in Action?

Once again, on October 1, 2010, the federal government's fiscal year started without completion of the budget process. Instead, Congress passed a continuing resolution allowing most branches of government to keep on spending at the same rate as last year until early December. The budget process has been completed on time, without continuing resolutions, only three times in the past 35 years.

Continuing resolutions, with their short time horizons and failure even to attempt optimization of policy, are an example of what Eric Leeper has called "fiscal alchemy." (Monetary Science, Fiscal Alchemy, presented at the Kansas City Fed's 2010 Jackson Hole conference.) "Monetary policy choices," writes Leeper, "tend to be based on systematic analysis of alternative policy choices and their associated macroeconomic impacts: this is science. Fiscal policy choices, in contrast, spring from unsystematic speculation, grounded more in politics than economics: this is alchemy."

Leeper sees another sign of fiscal alchemy in the long-term debt projections issued by the Congressional Budget Office. These project debt within limits marked by a "baseline scenario" that assumes no changes in law, and an "alternative scenario" that shows an exploding debt that cannot possibly be achieved. The gap between these two projections, neither of which can rationally be expected to occur, is not only large--it is growing larger every year. (He would like to see the CBO issue more realistic, model-based projections that would narrow, although not eliminate, the range of uncertainty.)

Although no one claims monetary policy is perfect, there is a great contrast between fiscal policy by continuing resolution, with no attempt at all to provide a stable framework for expectations, and the carefully worded policy statements issued by the Fed, which explicitly recognize the importance of anchoring expectations about the future course of policy.

In a rare comment on fiscal policy, Fed Chairman Ben Bernanke has recently noted that countries that continually spend beyond their means suffer slower growth in living standards. The only real question, Bernanke says, is whether the needed adjustments to fiscal policy will take place through a careful and deliberative process that weighs priorities and gives time to adjust to new policies, or whether it will be the kind of rapid and painful response to crisis that we have recently witnessed in Greece and elsewhere.

Follow this link to download a free set of classroom-ready slides that discuss continuing resolutions and fiscal alchemy.

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