FISCAL POLICY

Back in the pre-1930 days, government expenditures and taxes were only about 10 per cent of the national income. But in World War II this figure soared to 50 per cent, and during the 1950’s it fell back only to around 25 per cent. Federal, state, and local government spending of over $250 billion annually today exerts an enormous influence on the level and direction of the nation’s economic activity. And there is little reason to expect a return to the 1920’s.

Before the 1930’s, almost no one questioned the wisdom of balancing the federal budget every year. Sometimes the government didn’t manage to do it, but everyone was apologetic about the failure. But as the depression deepened in the 1930’s, the federal government just couldn’t balance the budget, try as both Mr. Hoover and Mr. Roosevelt would. We had federal deficit financing because we couldn’t help it. But an increasing number of people, led by the now-famous economist John Maynard Keynes, began to argue that the government’s excess spending was actually a good thing in depression. The argument went something like this.

The government should “prime the pump” of private spending. Everyone can agree that it would be foolish to try to have government receipts just equal expenditures every week or every month. Why, then, should the budget be balanced every year, instead of every two, or five, or ten years? Wouldn’t the sensible thing be to balance the budget roughly over the length of the business cycle? Government deficit spending in depression would help increase total spending and prime the private pump. Later, excess government taxes to pay off the debt in prosperity would help damp down the boom. The deficit would be a temporary expedient.

But as the long black years of the 1930’s dragged on, faith in both monetary policy and government pump-priming waned. Talk of a stagnant economy and a chronic deficiency in private investment spread. Emphasis shifted to continuing “compensatory” government spending, aimed at filling in the deficiency of private investment. According to the compensatory spenders, the private economy couldn’t carry itself forward to prosperity even when primed by doses of government investment. Government deficit spending should be continued as long and as heavily as necessary to attain and maintain full employment.