------------------------ http://www.econbrowser.com/archives/2009/09/state_and_local_1.html
Posted by: GK at September 5, 2009 11:51 AM
A history lesson.
In 1947 Herb Stein, Keynesian Chairman of Richard Nixon's Council of Economic Advisors developed the "full employment budget concept." In summary the concept was that the federal government excelled at tax collection, states excelled at government spending. The Keynesian tax policy (used by Kennedy) was inefficient. If congress was encouraged to lower taxes they would lower too much creating an “overheated" economy, but if congress was encouraged to increase taxes they would drag their feet allowing inflation. A better Keynesian idea, Stein postulated, is for the government to deficit spend as if the country were at full employment (4%), what Keynesians today would call "potential" GDP. If the government spends as if the economy were producing at full employment, then the economy would actually reach full employment and the deficit spending could slowly decrease. While no evidence indicats this would work small details have never stopped government economists from experimenting, after all "we must do something."
Nixon faced a budget problem when he entered office. Lyndon Johnson's "Great Society" not only took current tax revenues, it also took future revenues; budgets arrived in congress with a built in deficit. The Great Society passed tax collection to the states in what we today call unfunded mandates. The Great Society would provided 75% funding for a program if the state provided 25%. The states, not wanting to lose federal funding to other states, increased taxes to fund the 25% of the Great Society program.
By the time Nixon took office the states were crying to Washington to help fund federal social programs so state politicians did not have to continue to raise taxes.
The climate in 1970 was ripe. Unemployment was climbing and Nixon needed a new way to feed his "New Federalism," so Stein easily sold his 1947 idea. In January 1971 Nixon proposed a $4 billion revenue sharing scheme telling congress it would be a self-fulfilling prophecy.
But for the scheme to work Federal Reserve Chairman Arthur Burns had to expand the money supply. In April 1971 the National Observer reported that Burns at the beginning of the year was slow in providing the credit needed, but in April Burns proudly stated the country is "awash in credit." In the first two quarters of 1971 Burns increased the money supply 11% to stimulate the economy.
But the harsh world of unintended consequences – actually intended consequences since any rational economist should have seen them – US interest rates fell from 8% to 3.5% and money that was flowing into the US now flowed back to Europe, and gold flowed out of the US Treasury. The design of the Bretton Woods system made all currencies extensions of the dollar, so dollar inflation spread directly to the rest of the world. At the end of March 1971 the European bankers visited Burns begging him to slow his loosening of credit.
The US refused to end Stein’s Keynesian experiment, Burns continued his stimulus, and the Bretton Woods system exploded.
But wasn’t it worth it to reach Nixon’s goal of full employment? Unemployment at 5.6% in November 1971 moved up to 6% in April 1971 after Burns stimulus.
Today the Obama administration is repeating the foolishness of Nixon, Stein and Burns, but the difference is credit expansion funds “bubbles” rather than gold out-flow. Ultimately credit expansion will fund inflation just as Nixon’s policies created the inflationary 1970s. But more serious to the average person is unemployment. Those whose mantra is “unemployment is a lagging indicator” become tedious when rates are forecast to continue near Great Depression levels more than two years after stimulus was to have solved the problem.
“Those who don’t know history are destined to repeat it.” Edmund Burke
The Liberals, Communists and Progressives have a big problem. They think the only cure for problems caused by the policy is more Liberalism.