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Spring 2002 CalBusiness  
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Lesson 2

Lesson 2 is related: what we normally think of as "contractionary" fiscal policy need not harm economic growth. One reason is implicit in what we just said: expansionary monetary policy can offset any demand-reducing effects of budget cuts and tax hikes. But the 1993 budget agreement appears to have done more than that; it seems actually to have spurred the growth of aggregate demand even with no easing of monetary policy. The bond market, it appears, did the work for the Fed, as declining expected future deficits pulled down current long-term interest rates.

But "need not" is not synonymous with "will not." We argued earlier that a particularly fortuitous set of circumstances, market psychology, and design features of the budget agreement combined to ignite the 1993 bond market rally. We would not bet that this constellation can be replicated regularly, and hence we would not bet that all (nor even most) fiscal contractions will be expansionary. Still, under the right circumstances, the trick can be pulled off. And it appears to have been done in 1993.

Main Story / Lesson 1 / Lesson 2 / Lesson 3 / Lesson 4 / Lesson 5

 
Alan Blinder and Bill Clinton
 
Alan Blinder and Bill Clinton
 
 
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