Democracy in Deficit: The Political Legacy of Lord Keynes

James M. Buchanan.
Buchanan, James M. and Richard E. Wagner
(1919- )
CEE
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Editor/Trans.
First Pub. Date
1977
Publisher/Edition
Indianapolis, IN: Liberty Fund, Inc.
Pub. Date
1999
Comments
Foreword by Robert D. Tollison.

1. James M. Buchanan and Richard E. Wagner, Democracy in Deficit: The Political Legacy of Lord Keynes (New York: Academic Press, 1977), volume 8 in the series.

Chapter 1

2. For a formulation of this choice alternative in a British context, see Robin Pringle, "Britain Hesitates before an Ineluctable Choice," Banker 125 (May 1975): 493-496.

3. John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace, 1936).

4. See Richard M. Weaver, Ideas Have Consequences (Chicago: University of Chicago Press, 1948).

5. See Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (London: Oxford University Press, 1968); and G. L. S. Shackle, "Keynes and Today's Establishment in Economic Theory: A View," Journal of Economic Literature 11 (June 1973): 516-519. A somewhat different perspective is presented in Leland B. Yeager, "The Keynesian Diversion," Western Economic Journal 11 (June 1973): 150-163.

Chapter 2

6. Hugh Dalton, Principles of Public Finance, 4th ed. (London: Routledge and Kegan Paul, 1954), p. 221.

7. For a thorough examination of these classical principles and how they functioned as an unwritten constitutional constraint during the pre-Keynesian era, see William Breit, "Starving the Leviathan: Balanced Budget Prescriptions before Keynes" (Paper presented at the Conference on Federal Fiscal Responsibility, March 1976), to be published in a conference volume.

8. C. F. Bastable, Public Finance, 3rd ed. (London: Macmillan, 1903), p. 611.

9. Ibid.

10. For a survey of the balanced-budget principle, see Jesse Burkhead, "The Balanced Budget," Quarterly Journal of Economics 68 (May 1954): 191-216.

11. Knut Wicksell, Finanztheoretische Untersuchungen (Jena: Gustav Fischer, 1896). Translated as "A New Principle of Just Taxation" in R. A. Musgrave and A. T. Peacock, eds., Classics in the Theory of Public Finance (London: Macmillan, 1958), pp. 72-118.

12. Numerical details by year can be found in the "Statistical Appendix" to the Annual Report of the Secretary of the Treasury on the State of the Finances (Washington: U.S. Government Printing Office, 1976).

13. For a survey of our budgetary history through 1958, see Lewis H. Kimmel, Federal Budget and Fiscal Policy, 1789-1958 (Washington: Brookings Institution, 1959).

14. John W. Kearny, Sketch of American Finances, 1789-1835 (1887; reprint ed., New York: Greenwood Press, 1968), pp. 43-44.

15. Lance E. Davis, Jonathan R. T. Hughes, and Duncan M. McDougall, American Economic History, rev. ed. (Homewood, Ill.: Richard D. Irwin, 1965), p. 420. See also Reginald C. McGrane, The Panic of 1837 (New York: Russell and Russell, 1965).

16. See James M. Buchanan, Public Principles of Public Debt (Homewood, Ill.: Richard D. Irwin, 1958); and James M. Buchanan and Richard E. Wagner, Public Debt in a Democratic Society (Washington: American Enterprise Institute, 1967).

17. For an analysis of the possibilities for debt abuse within a political democracy, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), pp. 256-266; and Richard E. Wagner, "Optimality in Local Debt Limitation," National Tax Journal 23 (September 1970): 297-305.

18. For a summary of the literature, see Buchanan, Public Principles of Public Debt, pp. 16-20.

19. For examinations of this categorical shift in the scope of fiscal policy during the 1930s, see Ursula K. Hicks, British Public Finances: Their Structure and Development, 1880-1952 (London: Oxford University Press, 1954); and Lawrence C. Pierce, The Politics of Fiscal Policy Formation (Pacific Palisades, Calif.: Goodyear, 1971). With reference to Great Britain, Hicks noted:

    Fiscal policy in the sense of a purposeful marshalling of the armoury of public finance in order to influence the level of incomes cannot be said to have been recognized as an art before the middle or late 1930s. Up to that time considerations of public finance ran in terms only of the effects of individual taxes and outlays, on particular aspects of economic life, without regard to the total effect. [p. 140]

With reference to the United States, Pierce observed:

    Until the late 1930s, the role of the government budget was limited to providing public services, raising taxes to pay for them, and, less often, influencing the distribution of income among regions and individuals. It is only since the late 1930s that economists and political leaders have come to believe that they can also use the federal budget to help avoid most of the economic ills associated with high levels of unemployment, price inflation, and economic stagnation. [p. 1]

20. See Breit.

21. Harry G. Johnson, "Living with Inflation," Banker 125 (August 1975): 863-864.

Chapter 3

22. John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace, 1936), p. vi.

23. In various works, Professor Axel Leijonhufvud of UCLA has examined the impact of Keynesian ideas on economists in some detail. We are indebted to his insights here, which supplement our much less comprehensive examination of the intellectual history.

Robert Skidelsky, "Keynes and the Revolt against the Victorians," Spectator, 1 May 1976, pp. 14-16, contrasts the Keynesian and the Victorian world views. While the Victorian emphasis was on a goal-directed life, the Keynesian emphasis stressed living in the present. Keynes' assault on saving and thrift is one consequence of this shift in Weltanschauung.

24. For a recent, careful restatement of this position, see W. H. Hutt, A Rehabilitation of Say's Law (Athens: Ohio University Press, 1974).

25. See Axel Leijonhufvud, "Effective Demand Failures," Swedish Journal of Economics 75 (March 1973): 27-48, for a description of these two alternative paradigms and a discussion of how they influence the economist's analytical perspective.

26. One important element in the articulation of this Keynesian position was the presence of persistently high unemployment throughout the 1930s. Such a record seemed to vitiate the classical belief in a self-adjusting economy. This entire record, it now turns out, is false, for substantial numbers (2-3.5 million) of governmental employees were counted as being unemployed. When a correct accounting is made for such persons, the pattern changes starkly to one of a rapid and continuous reduction in unemployment from 1932 until the recession of 1937-1938, which itself resulted from the Federal Reserve's doubling of reserve requirements between August 1936 and May 1937. This piece of detective work is due to Michael R. Darby, "Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, an Explanation of Unemployment, 1934-1941," Journal of Political Economy 84 (February 1976): 1-16.

27. Stephen K. Bailey, Congress Makes a Law (New York: Columbia University Press, 1950), is the standard legislative history of the enactment of the Employment Act of 1946.

28. Such forecasts include S. Morris Livingston, "Forecasting Postwar Demand," Econometrica 13 (January 1945): 15-24; Richard A. Musgrave, "Alternative Budget Policies for Full Employment," American Economic Review 35 (June 1945): 387-400; National Planning Association, National Budgets for Full Employment (Washington: National Planning Association, 1945); and Arthur Smithies, "Forecasting Postwar Demand," Econometrica 13 (January 1945): 1-14. Such postwar forecasts were criticized in Albert G. Hart, " 'Model-Building' and Fiscal Policy," American Economic Review 35 (September 1945): 531-558.

29. The clearest exposition of a position that was widely shared is found in Abba P. Lerner, The Economics of Control (New York: Macmillan, 1944), pp. 285-322.

30. For completeness, we should note here that the Keynesian theory of policy, as developed in the 1940s and 1950s, included the balanced-budget multiplier. Aggregate spending in the economy might be increased by an increase in government outlays, even if budget balance is strictly maintained, because of the fact that the increased tax revenues would be drawn, in part, from private savings. The standard exposition of this proposition is William J. Baumol and Maurice H. Peston, "More on the Multiplier Effects of a Balanced Budget," American Economic Review 45 (March 1955): 140-148.

31. Richard A. Musgrave, in reviewing Alvin Hansen's role in the selling of Keynesianism in the 1940s, acknowledged the pivotal position occupied by the classical theory of public debt when he wrote: "The battle for full employment had to be continued, and the counteroffensive, built around the alleged dangers of a rising public debt, had to be met." See Musgrave's contribution to the symposium on Alvin H. Hansen: "Caring for the Real Problems," Quarterly Journal of Economics 90 (February 1976): 5.

32. The "new orthodoxy" was first challenged explicitly by James M. Buchanan in 1958. In his book, Public Principles of Public Debt (Homewood, Ill.: Richard D. Irwin, 1958), Buchanan specifically refuted the three main elements of the Keynesian theory, and he argued that, in its essentials, the pre-Keynesian classical theory of public debt was correct. Buchanan's thesis was widely challenged and a lively debate among economists took place in the early 1960s. Many of the contributions are included in James M. Ferguson, ed., Public Debt and Future Generations (Chapel Hill: University of North Carolina Press, 1964). For a summary treatment, see James M. Buchanan and Richard E. Wagner, Public Debt in a Democratic Society (Washington: American Enterprise Institute, 1967). Buchanan sought to place elements of the debt-burden discussion in a broader framework of economic theory in his book, Cost and Choice (Chicago: Markham, 1968). For a later paper that places the debt-burden discussion in a cost-theory perspective, see E. G. West, "Public Debt Burden and Cost Theory," Economic Inquiry 13 (June 1975): 179-190.

Chapter 4

33. For a general discussion of fiscal policy in the 1930s, with an emphasis on the effects of the tax increase of 1932, see E. C. Brown, "Fiscal Policy in the Thirties: A Reappraisal," American Economic Review 46 (December 1956): 857-879.

34. Cited in Fredrick C. Mosher and Orville F. Poland, The Costs of American Government (New York: Dodd, Mead, 1964), p. 73.

35. For a discussion of the attitudes of American economists in the early 1930s, particularly those associated with the University of Chicago, see J. Ronnie Davis, The New Economics and the Old Economists (Ames: Iowa State University Press, 1971).

36. Gottfried Haberler observed, with reference to Keynes, that "no 'classical' economist had propagated the case for easy money and deficit spending with the same energy, persuasiveness, and enthusiasm as Keynes, and with the seemingly general theoretical underpinning, and that many orthodox economists rejected these policies outright." See Haberler's contribution to the symposium on Alvin H. Hansen: "Some Reminiscences," Quarterly Journal of Economics 90 (February 1976): 11.

37. For an early analysis, see Richard A. Musgrave and Merton H. Miller, "Built-in Flexibility," American Economic Review 38 (March 1948): 122-128.

38. Committee for Economic Development, Taxes and the Budget: A Program for Prosperity in a Free Economy (New York: Committee for Economic Development, 1947). This proposal, along with the intellectual antecedents, is discussed in Walter W. Heller, "CED's Stabilizing Budget Policy after Ten Years," American Economic Review 47 (September 1957): 634-651.

39. Milton Friedman, "A Monetary and Fiscal Framework for Economic Stability," American Economic Review 48 (June 1948): 245-264.

40. For a summary discussion, see Heller. It should be noted that Heller distinguished between a "tranquilizing budget policy" and a "stabilizing budget policy," and threw his support to the latter.

41. In his book, Taxation: The People's Business (New York: Macmillan, 1924), Mellon not only noted that "the government is just a business, and can and should be run on business principles ..." (p. 17), but also remarked approvingly that "since the war two guiding principles have dominated the financial policy of the Government. One is the balancing of the budget, and the other is the payment of the public debt. Both are in line with the fundamental policy of the Government since its beginning" (p. 25).

42. The interest in revenue sharing that surfaced in the early 1960s was, at that time, sparked in part by a desire to offset fiscal drag. Rather than cutting taxes to avoid fiscal drag, it was proposed that revenues be transferred to state and local governments. For references to what, at the time, was referred to as the "Heller-Pechman proposal," see Walter W. Heller, "Strengthening the Fiscal Base of Our Federalism," in New Dimensions of Political Economy (Cambridge: Harvard University Press, 1966), pp. 117-172; and Joseph A. Pechman, "Financing State and Local Government," in Proceedings of a Symposium on Federal Taxation (New York: American Bankers Association, 1965), pp. 71-85.

43. Herbert Stein, The Fiscal Revolution in America (Chicago: University of Chicago Press, 1969), p. 375. We should acknowledge our indebtedness to Stein's careful and complete history of fiscal policy over the whole post-Keynesian period before the late 1960s. Our interpretation differs from that advanced by Stein largely in the fact that we have had an additional decade in which to evaluate the record, the events of which have done much to reduce the faith of economists, regardless of their ideological persuasion, in the basic Keynesian precepts.

44. Abba P. Lerner, "Functional Finance and the Federal Debt," Social Research 10 (February 1943): 38-51; and idem, The Economics of Control (New York: Macmillan, 1944), pp. 285-322.

45. Henry C. Wallich, an economist as well as a member of the Federal Reserve Board, has fully recognized this effect of monetarist prescriptions. He stated: "Increasingly, monetarist prescriptions play a role in political discussions.... The elected representatives of the people have discerned the attraction of monetarist doctrine because it plays down the effects of fiscal policy. Deficits can do no major damage so long as the central bank does its job right." Wallich then goes on to suggest that the monetary authorities, "for the same reason, have tended to preserve a degree of faith in Keynesianism." Citations are from Henry C. Wallich, "From Multiplier to Quantity Theory," preliminary mimeographed paper, 23 May 1975.

Chapter 5

46. Kenneth E. Boulding, Economics as a Science (New York: McGraw-Hill, 1970), p. 151.

47. We cannot attribute the increase in state and local government spending over this period directly to the abandonment of the balanced-budget norm, since these units lack powers of money creation and, hence, are effectively constrained by something akin to the old-fashioned fiscal principles. Even here, however, it could be argued that the release of spending proclivities at the federal level may have influenced the whole political attitude toward public spending. Furthermore, much of the observed increase in state-local spending is attributable to federal inducements via matching grants and to federal mandates, legislative, administrative, and judicial.

Along these lines, one might point out that state and local expenditures have actually been increasing relative to federal expenditures since 1960. In 1960, state and local expenditures were 53.5 percent of federal expenditures, but by 1975 this percentage had risen to 62.3 percent. For these data, see the Economic Report of the President (Washington: U.S. Government Printing Office, 1976), pp. 249-251. The growth of government, it would appear, has been especially rapid among the lower levels of government.

Such data, however, are exceedingly misleading, for they attribute to state and local governments those expenditures that were financed by grants from the federal government. Such grants totaled $6.9 billion in 1960, and had swollen to $48.3 billion in 1975. Removing such grants from the figures for state and local expenditures changes the interpretation considerably. State and local expenditures are now seen to be 46.1 percent of federal expenditure in 1960, increasing only to 48.8 percent in 1975. Moreover, federal grants customarily are offered on a matching basis, which generally stimulates additional state and local expenditure. This portion of expenditure that is a result of the stimulating input of federal grants should also properly be attributed to the federal government. If it is assumed that each dollar of federal grant stimulates state and local spending by 20%, state and local spending as a percentage of federal spending was practically stable over the 1960-1975 period, rising only from 43.9 percent to 44.8 percent. The figure of a 20-percent rate of stimulation is consistent with that found in Edward M. Gramlich, "Alternative Federal Policies for Stimulating State and Local Expenditures: A Comparison of Their Effects," National Tax Journal 21 (June 1968): 119-129.

48. That the Truman-Eisenhower years were indeed transitional becomes apparent once it is recalled that such a period previously would have been accompanied by a cumulative budget surplus, with the surplus used to retire public debt. The decade following World War I, 1920-1929, for instance, saw ten consecutive surpluses, with the total surplus exceeding $7.6 billion. This surplus made possible a 30-percent reduction in the national debt. Prices were generally stable, but with a slight downward drift. Prices did fall sharply during the contraction of 1920-1921, but were stable thereafter. Wholesale prices fell by nearly 40 percent between 1920 and 1921, while consumer prices fell by a little over 10 percent. From then on, approximate stability reigned: Wholesale prices fell by slightly less than 3 percent during the remainder of the decade, while consumer prices declined by slightly over 4 percent. Moreover, the share of government in the economy actually declined, falling from 14.7 percent in 1922 (figures for 1920 are not available) to 11.9 percent in 1929.

49. David Laidler and Michael Parkin advance a similar position when they observe: "It is central to modern work on the role of the government budget constraint in the money supply process that an expansionary fiscal policy met by borrowing from the central bank will result in sustained monetary expansion.... In the light of this work the question as to whether monetary expansion is a unique 'cause' of inflation seems to us to be one mainly of semantics" ("Inflation: A Survey," Economic Journal 85 [December 1975]: 796).

50. The massive cumulative deficit since 1960 has been accompanied by a substantial shortening of the maturity structure of marketable issues of national debt. In 1960, 39.8 percent of such debt was scheduled to mature within one year. By 1975, this figure had expanded to 55 percent. While 12.8 percent of such debt had a maturity date of ten years or longer in 1960, this figure had shrunk to 6.8 percent in 1975. This shortening of the maturity structure reinforced the outright monetization of budget deficits that occurred during this period (Source: Federal Reserve Bulletin).

51. See the analysis in Reuben A. Kessel and Armen A. Alchian, "The Effects of Inflation," Journal of Political Economy 70 (December 1962): 521-537.

52. See Phillip Cagan, The Hydra-Headed Monster: The Problem of Inflation in the United States (Washington: American Enterprise Institute, 1974).

53. See, for instance, Martin J. Bailey, "The Welfare Cost of Inflationary Finance," Journal of Political Economy 64 (April 1956): 93-110; and Alvin L. Marty, "Growth and the Welfare Cost of Inflationary Finance," Journal of Political Economy 75 (February 1967): 71-76.

54. John Maynard Keynes, The Economic Consequences of the Peace (New York: Harcourt, Brace, 1920), p. 236.

55. Joseph A. Schumpeter, Capitalism, Socialism, and Democracy, 3rd ed. (New York: Harper and Row, 1950), p. 424.

56. On this point, see Axel Leijonhufvud's careful, contrary-to-conventional-wisdom analysis of inflation from this institutionalist perspective, "Costs and Consequences of Inflation," manuscript, May 1975.

57. See ibid.

58. For an elaboration of these and related issues, see David Meiselman, "More Inflation, More Unemployment," Tax Review 37 (January 1976): 1-4.

59. This point suggests the hypothesis that democracies will impose controls on private producers more rapidly and profusely under inflationary conditions than under conditions of price-level stability. Casual empiricism surely supports this hypothesis, but more sophisticated testing would be helpful.

60. An anticipation of future rates of inflation can be formed without a correct understanding as to why the inflation is taking place. A long-term historical experience in which prices rise by roughly 10 percent annually will come to inform the nominal terms of trade, regardless of what particular explanation individuals may happen to attribute to the observed inflationary pressures.

61. Wilhelm Röpke recognized this consequence of inflation when he remarked: "Inflation, and the spirit which nourishes it and accepts it, is merely the monetary aspect of the general decay of law and of respect for law. It requires no special astuteness to realize that the vanishing respect for property is very intimately related to the numbing of respect for the integrity of money and its value. In fact, laxity about property and laxity about money are very closely bound up together; in both cases what is firm, durable, earned, secured and designed for continuity gives place to what is fragile, fugitive, fleeting, unsure and ephemeral. And that is not the kind of foundation on which the free society can long remain standing" (Welfare, Freedom and Inflation [Tuscaloosa: University of Alabama Press, 1964], p. 70).

62. For a general discussion of this point, see William H. Peterson, "The Impact of Inflation on Management Decisions," Freeman 25 (July 1975): 399-411.

63. The switch from FIFO to LIFO methods of inventory valuation, which has been taking place in recent years, is one particular attempt to deal with the reduced accuracy of accounting information in an inflationary environment. For a careful examination of this problem, see George Terborgh, Inflation and Profits (New York: Machinery and Allied Products Institute, 1974).

64. These figures are reported in Reginald H. Jones, "Tax Changes Can Help Close Capital Gap," Tax Review 36 (July 1975): 29-32. See also Norman B. Ture, "Capital Needs, Profits, and Inflation," Tax Review 36 (January 1975): 1-4; and C. Lowell Harriss, "Tax Fundamentals for Economic Progress," Tax Review 36 (April 1975): 13-16.

65. This proposition about "crowding out" is surveyed in Keith M. Carlson and Roger W. Spencer, "Crowding Out and Its Critics," Federal Reserve Bank of St. Louis, Review 57 (December 1975): 2-17.

66. Some comparative figures released by the U.S. Treasury Department are instructive in this respect. During the 1963-1970 period covered by the study, the share of national output that was devoted to additions to the capital stock was considerably less in the United States than in several of the relatively progressive industrialized nations. Our rate of capital investment was 13.6 percent. This rate was 17.4 percent in Canada, 18.2 percent in France, 20 percent in West Germany, and 29 percent in Japan.

67. In this and the immediately preceding paragraphs, we have introduced, all too briefly, elements of the so-called "Austrian theory" of the cycle. We feel that the emphasis on the structural maladjustments that can result from monetary disturbances is an important insight, especially in the political context we have been describing. At the same time, however, we retain essentially a monetarist interpretation of such a phenomenon as the Great Depression, as well as a belief in the usefulness of aggregate demand stimulation under such circumstances. The forces of secondary deflation that operate under rigid wages and prices seem to us to overwhelm those real maladjustments that are those of the primary depression itself. Our position on the relation between the Austrian and monetarist interpretations is quite similar to that found in Gottfried Haberler, The World Economy, Money, and the Great Depression, 1919-1939 (Washington: American Enterprise Institute, 1976), pp. 21-44.

68. Colin Clark, "Public Finance and Changes in the Value of Money," Economic Journal 55 (December 1945): 371-389.

69. Harry G. Johnson, "Living with Inflation," Banker 125 (August 1975): 863-864.

70. See Graham Hutton, "Taxation and Inflation," Banker 125 (December 1975): 1493-1499.

71. In recent years, an expanding body of thought, both conceptual and empirical, has been developing in support of the proposition that, at the prevailing margins of choice, resources employed in the public sector are less efficient than resources employed in the private sector. For a sample of this literature, see William A. Niskanen, Bureaucracy and Representative Government (Chicago: Aldine, 1971); Thomas E. Borcherding, ed., Budgets and Bureaucrats (Durham, N.C.: Duke University Press, 1976); Roger Ahlbrandt, "Efficiency in the Provision of Fire Services," Public Choice 16 (Fall 1973): 1-16; David G. Davies, "The Efficiency of Private versus Public Firms: The Case of Australia's Trio Airlines," Journal of Law and Economics 14 (April 1971): 144-165; William A. Niskanen, "Bureaucracy and the Interests of Bureaucrats," Journal of Law and Economics 18 (December 1975): 617-643; and Richard E. Wagner and Warren E. Weber, "Competition, Monopoly, and the Organization of Government in Metropolitan Areas," Journal of Law and Economics 18 (December 1975): 661-684.

72. For a description and analysis of our movement from a gold standard to a fiduciary standard, see Benjamin Klein, "Our New Monetary Standard: The Measurement and Effects of Price Uncertainty, 1880-1973," Economic Inquiry 13 (December 1975): 461-484.

73. Haberler suggests that, if there is uniform resistance to deflation, a balance of payments disequilibrium may be resolved through inflation in surplus countries, rather than through deflation in deficit countries. Gottfried Haberler, "The Future of the International Monetary System," Zeitschrift für Nationalökonomie 34, no. 3-4 (1974): 387-396.

74. For an examination of the relation between the international monetary system and domestic monetary policy, see Harry G. Johnson, Inflation and the Monetarist Controversy (Amsterdam: North-Holland, 1972).

75. David Fand has discussed in some detail the relationship between the shift to floating rates and the prospects for inflation. He argues that the excess reserves produced by the shift tended to be inflationary in the transitional period but that the enhanced control of the national monetary authorities should lead to less inflation over a longer term. In this analysis, Fand neglects the possible increased vulnerability of national monetary authorities to domestic political pressures, a point that we discuss in Chapter 8. See David I. Fand, "World Reserves and World Inflation," Banca Nazionale del Lavoro Quarterly Review 115 (December 1975): 3-25.

76. Recognizing this relationship does not necessarily imply the superiority of a fixed exchange-rate system. The choice between a floating and a fixed system rests, finally, on predictions about the operation of domestic decision makers on the one hand and foreign decision makers, in the aggregate, on the other. Floating rates provide protection against exogenous foreign influences on the domestic economy. But, at the same time, they make the economy considerably more vulnerable to unwise manipulation by domestic politicians.

77. Graham Hutton, What Killed Prosperity in Every State from Ancient Rome to the Present (Philadelphia: Chilton Book, 1960), p. 96.

Chapter 6

1. "We have seen that he [Keynes] was strongly imbued with what I have called the presuppositions of Harvey Road. One of these presuppositions may perhaps be summarized in the idea that the government of Britain was and could continue to be in the hands of an intellectual aristocracy using the method of persuasion" (R. F. Harrod, The Life of John Maynard Keynes [London: Macmillan, 1951], pp. 192-193). Harvey Road was the location of the Keynes family residence in Cambridge.

As Smithies put it: "Keynes hoped for a world where monetary and fiscal policy, carried out by wise men in authority, could ensure conditions of prosperity, equity, freedom, and possibly peace.... He thus hoped that his economic ideas could be put into practice outside the arena of partisan politics, but failed to realize that his own efforts tended to make this impossible" (Italics supplied; Arthur Smithies, "Reflections on the Work and Influence of John Maynard Keynes," Quarterly Journal of Economics 65 [November 1951]: 493-494).

2. Ibid., p. 193.

3. This is clearly indicated by Keynes' statement in the foreword to the German edition of his General Theory: "Nonetheless, the theory of output as a whole, which is what the following book purports to provide, is much more easily adopted to the conditions of a totalitarian state, than is the theory of production and distribution of a given output produced under the conditions of free competition and a large measure of laissez-faire" (Quoted and translated in George Garvey, "Keynes and the Economic Activists of Pre-Hitler Germany," Journal of Political Economy 83 [April 1975]: 403).

4. Paul A. Samuelson suggested the opposite, while affirming our thesis in the process, when he argued that "America, rather than Britain, was the natural place where the Keynesian model applied: the United States was largely a closed, continental economy with an undervalued dollar that gave ample scope for autonomous macroeconomic policies ..." (Samuelson, "Hansen as a Creative Theorist," Quarterly Journal of Economics 90 [February 1976]: 26). By ignoring the institutions through which policy emerges, Samuelson, like Keynes, seems to be accepting the presuppositions of Harvey Road.

5. Knut Wicksell, Finanztheoretische Untersuchungen (Jena: Gustav Fischer, 1896). Translated as "A New Principle of Just Taxation," in Richard A. Musgrave and Alan T. Peacock, eds., Classics in the Theory of Public Finance (London: Macmillan, 1958), pp. 72-118.

6. Herschel I. Grossman, "Tobin on Macroeconomics: A Review Article," Journal of Political Economy 83 (August 1975): 845-846.

7. In this 1963 statement, Samuelson noted that this policy package had been "advocated for many years by such liberal economists as James Tobin, E. C. Brown, R. A. Musgrave and me." See Paul A. Samuelson, "Fiscal and Financial Policies for Growth," in Proceedings—A Symposium of Economic Growth (Washington: American Bankers Association, 1963), pp. 78-100. Reprinted in The Collected Scientific Papers of Paul A. Samuelson, vol. 2, ed. Joseph Stiglitz (Cambridge, Mass.: MIT Press, 1966), pp. 1387-1403; citation from p. 1402.

As early as 1955, Samuelson had explicitly posed this policy mix, but without strong advocacy. See his "The New Look in Tax and Fiscal Policy," Joint Committee on the Economic Report, 84th Congress, 1st Session, Federal Tax Policy for Economic Growth and Stability, November 1955, pp. 229-234. Reprinted in Papers of Paul A. Samuelson, vol. 2, pp. 1325-1330.

For evidence to the effect that modern economists continue to accept the Keynesian political presuppositions, we may look at a 1975 Brookings Institution analysis of capital needs, in which it is argued that capital shortage concerns can be alleviated if the federal government follows a budget-surplus, easy-money policy. See Barry Bosworth, James S. Duesenberry, and Andrew S. Carron, Capital Needs in the Seventies (Washington: Brookings Institution, 1975).

8. The political pressures generating this result were discussed in James M. Buchanan, "Easy Budgets and Tight Money," Lloyds Bank Review 64 (April 1962): 17-30.

9. The influential paper was A. W. Phillips, "The Relation between Unemployment and the Rate of Change in Money Wage Rates in the United Kingdom, 1951-1957," Economica 25 (November 1958): 283-299. The relationship had been noted much earlier and was statistically estimated by Irving Fisher in 1926. For a discussion of the history, see Donald F. Gordon, "A Neo-Classical Theory of Keynesian Unemployment," Economic Inquiry 12 (December 1974): 434ff especially.

10. This formulation of "optimal" policy choice was initiated in Paul A. Samuelson and Robert M. Solow, "Analytical Aspects of Anti-Inflation Policy," American Economic Review, Papers and Proceedings 50 (May 1960): 177-194.

11. For an explanation, see Milton Friedman, "The Role of Monetary Policy," American Economic Review 58 (March 1968): 1-17.

12. The Balanced Growth and Economic Planning Act of 1975 included the proposed establishment of a complex set of both executive and congressional offices of national economic planning, along with complex coordination procedures. This proposed legislation was subsequently replaced by the Full Employment and Balanced Growth Act of 1976, commonly discussed as the Humphrey-Hawkins bill, which also embodies the creation of an advisory committee along with complex procedures for coordination. Over and beyond this, the proposed act mandated an unemployment target of 3 percent, to be attained within four years. For a generalized critique of the concept of national economic planning, see L. Chickering, ed., The Politics of Planning (San Francisco: Institute for Contemporary Studies, 1976).

Chapter 7

13. See Karl Brunner, "Knowledge, Values, and the Choice of Economic Organization," Kyklos 23, no. 3 (1970): 558-580, for an examination of the impact of paradigms, which provide the framework for interpreting experiences, upon particular elements of public policy. See W. H. Hutt, A Rehabilitation of Say's Law (Athens: Ohio University Press, 1974), for an interpretative survey of Say's Equality.

14. A direct corollary of the view that aggregative shifts are not self-correcting is the notion, even if this is implicit, that such shifts cannot themselves be the results of distorting elements in market structure. Applied to employment, this suggests a tendency to attribute all shifts downward in observed rates of employment to fluctuations in aggregate demand. In such a policy setting, government intervention to correct for increased unemployment that is, in fact, caused by labor market dislocation and structural rigidities acts to cement the latter into quasipermanence and to make ultimate correction more difficult.

15. For a more complete examination of similarities and differences, see James M. Buchanan, "Individual Choice in Voting and the Market," Journal of Political Economy 62 (August 1954): 334-343. Reprinted in James M. Buchanan, Fiscal Theory and Political Economy (Chapel Hill: University of North Carolina Press, 1960), 90-104.

16. For a recent survey of the literature on the properties of political competition, see William H. Riker and Peter C. Ordeshook, An Introduction to Positive Political Theory (Englewood Cliffs, N.J.: Prentice-Hall, 1973).

17. Anthony Downs, An Economic Theory of Democracy (New York: Harper and Row, 1957), pp. 51-74, suggested that the size of the budget in a democracy can be viewed as the outcome of a process in which politicians continue to expand the budget so long as the marginal vote gain from public expenditure exceeds the marginal vote loss from the taxation required to finance the expenditure.

18. See Riker and Ordeshook for such a survey.

19. To remain in office, the politician need not meet the demands of all constituents. Instead, he need satisfy only a required subset, usually a majority. Because majority coalitions shift as among different policy issues, the behavior of the politician who seeks to maintain majority support need not reflect properties of rationality normally attributable to an individual who chooses among private alternatives. This feature of democratic politics has been exhaustively discussed by social scientists since Kenneth Arrow formally proved what he called the "impossibility theorem" in 1951. See Kenneth J. Arrow, Social Choice and Individual Values (New York: Wiley, 1951).

20. It should be noted that our analysis does not imply that government borrowing is never justified. Under certain conditions, resort to borrowing may be required for efficient fiscal decisions. Our analysis does suggest that, unless constraints are introduced to ensure that borrowing is limited to such conditions, the opportunity for borrowing will bring about an expansion in the size of the public sector.

21. If, in fact, there should be no effective difference between government debt issue and taxation, essentially the Ricardian view, which we examine in more detail in Chapter 9, neither of these biases would be of import. The first would not exist at all, while the second would be meaningless.

22. Our analysis here is limited to the demonstration that the symmetry in the creation of budget surpluses and deficits required for efficacy in the operation of a Keynesian-oriented fiscal policy will not emerge in political democracy in the absence of constitutional constraints. We shall not, at this point, discuss the political problems that arise in the creation of budget surpluses when the purpose is that of reducing the size of the public debt outstanding, independently of fiscal policy considerations. Many of the same difficulties in trading off short-term costs for long-term gains would, of course, arise. And perhaps the strongest support for the basic hypothesis that the Keynesian conversion has effectively changed the fiscal constitution lies in the dramatic difference between the pre-Keynesian and the post-Keynesian record of debt retirement. Despite the short-term costs, budget surpluses were created, and public debt was retired, in all postemergency periods prior to World War II in the United States.

23. This point about the categorical difference between present and future has been a theme of many of the writings of G. L. S. Shackle. A terse statement of this theme appears in his Epistemics and Economics (Cambridge: Cambridge University Press, 1972), p. 245: "We cannot have experience of actuality at two distinct 'moments.' The moment of actuality, the moment in being, 'the present,' is solitary. Extended time, beyond 'the moment,' appears in this light as a figment, a product of thought" (Shackle's italics).

24. And even to the extent that citizens do creatively imagine such alternative, conjectural futures, democratic budgetary processes may produce a different form of bias against the surplus. To the extent that budgetary institutions permit fragmented appropriations, for instance, a public-choice analogue to the prisoners' dilemma will tend to operate to dissipate revenues that might produce a budget surplus. Suppose, for instance, that a potential $10 billion budget surplus is prevented from arising because of the presentation of ten separate spending proposals of $1 billion each, as opposed to the presentation of a single expenditure proposal of $10 billion. In the first case, although each participant may recognize that he would be better off if none of the spending proposals carry, institutions that allow separate, fragmented budgetary consideration may operate to create a result that is mutually undesirable. For an analysis of this possibility, see James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962), Ch. 10 especially.

25. Budget surpluses, of course, would have the reverse relative price change. We consider only the consequences of deficit because democratic political institutions produce a bias toward deficits, not toward surpluses.

26. The model summarized here is essentially equivalent to the one analyzed more fully in James M. Buchanan, "Fiscal Policy and Fiscal Preference," Public Choice 2 (Spring 1967): 1-10. Reprinted in James M. Buchanan and Robert D. Tollison, eds., Theory of Public Choice (Ann Arbor: University of Michigan Press, 1972), pp. 76-84.

27. See Friedrich A. Hayek, Prices and Production, 2d ed. (London: Routledge and Kegan Paul, 1935), for an early though neglected explanation of this theme. It should perhaps be noted that Hayek developed his analysis in terms of an excessive attraction of resources into the production of capital goods. This resulted from monetary expansion which drove the market rate of interest below the real rate. In these days of massive public spending, however, the story is more complex, for the objects of the increased public spending also generate an excessive attraction of resources.

28. Milton Friedman has offered much the same assessment of the political impact of Keynesianism: Keynesian policy norms "are part of economic mythology, not the demonstrated conclusions of economic analysis or quantitative studies. Yet they have wielded immense influence in securing widespread public backing for far-reaching governmental interference in economic life" (Italics supplied; Milton Friedman, Capitalism and Freedom [Chicago: University of Chicago Press, 1962], p. 84).

Chapter 8

29. In an economic environment where an increase in the supply of money causes prices to rise, some rational expectations models may produce something akin to the Ricardian proposition. In this case, there would be no output-employment effects of money-financed deficits, even in the short run. Money-financed deficit creation would, in this model, be a form of current taxation, with no real effects on disposable income and no substitution effect as between public and private goods. These models seem, however, to be even more bizarre in the informational requirements they place on individuals than is the comparable Ricardian model. For instance, they require that the expectations of economic agents are the same as those implied by the solution of the economic model in which they are assumed to exist. Ah, but if only all economists could agree upon a single model! For an exposition by a true believer, of which there are several, see Robert J. Barro, "Rational Expectations and the Role of Monetary Policy," Journal of Monetary Economics 2 (January 1976): 1-32.

30. One means of eliminating the public-sector bias might involve the institutionalization of Musgrave's analytical separation of the budget into branches. A constitutional rule might require that the allocation budget be kept strictly in balance, while a separate stabilization branch might be empowered to issue new money and distribute it directly to citizens (by helicopter drop or otherwise) on the one hand, and to levy taxes and to destroy the proceeds on the other. The effective operation of such a set of institutions could eliminate the public-sector bias resulting from the "price" effect discussed. The inflationary bias would not, however, be eliminated under such a regime, and, if anything, the political pressures on an independently organized stabilization branch might be even more severe than those present under a consolidated budget. For the original discussion of the analytical basis of the three-branch budget, see R. A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959).

31. David Fand, for instance, rejects the suggestion that the supply of money is endogenous, because he interprets such a proposition as signifying an acceptance of the real-bills doctrine. Our perspective on the endogenous character of the money stock as it relates to budget deficits, however, is quite different and is fully consistent with a monetarist perspective. See David I. Fand, "Can the Central Bank Control the Money Stock?" Federal Reserve Bank of St. Louis, Review 52 (January 1970): 12-16.

32. For simplicity here, we may assume that government must borrow in only one type of security. It cannot, by assumption, change the overall "moneyness" of debt by modifying debt structure.

33. The proposition that monetary authorities cannot be treated as truly independent of the financial activities of the Treasury, at least when government expenditure and government debt comprise relatively large parts of national income and total credit respectively, is advanced in R. S. Sayers, Central Banking after Bagehot (Oxford: Oxford University Press, 1957), pp. 92-107. Bagehot, by the way, set forth over a century ago (1873) essentially a public-choice-property-rights approach to monetary institutions. See Walter Bagehot, Lombard Street: A Description of the Money Market, 11th ed. (London: Kegan, Paul, Trench, Trubner, 1894 [1873]). The importance of relating inflation to politics has recently been stressed by Thomas Wilson, "The Political Economy of Inflation," Proceedings of the British Academy, vol. 61 (Oxford: Oxford University Press, 1975), pp. 3-25.

34. Cf. Gordon Tullock, "Public Decisions as Public Goods," Journal of Political Economy 79 (August 1971): 913-918.

35. E. Ray Canterbery, Economics on a New Frontier (Belmont, Calif.: Wadsworth, 1968), pp. 155-171, explicitly advocates that Federal Reserve nominal independence be replaced by direct political control.

36. There is some empirical evidence to suggest that the behavior of persons in monetary authorities is explained by hypotheses that have emerged from the theory of bureaucracy. See Keith Acheson and John F. Chant, "The Choice of Monetary Instruments and the Theory of Bureaucracy," Public Choice 12 (Spring 1972): 13-34; and idem, "Bureaucratic Theory and the Choice of Central Bank Goals," Journal of Money, Credit, and Banking 5 (May 1973): 637-655. For a general survey of various efforts to examine positively the conduct of the Federal Reserve authorities, see William P. Yohe, "Federal Reserve Behavior," in William J. Frazer, Jr., ed., Crisis in Economic Theory (Gainesville: University of Florida Press, 1974), pp. 189-200.

37. Several studies of the link between budget deficits and monetary expansion have treated interest rates as the mediator that creates the link. Budget deficits will tend to depress the price of government securities, thereby placing upward pressure on interest rates. The Federal Reserve, in turn, acts to offset this upward pressure by purchasing government securities. In consequence, monetary expansion takes place. For discussions of this point, see Raymond E. Lombra and Raymond G. Torto, "The Strategy of Monetary Policy," Federal Reserve Bank of Richmond, Monthly Review 61 (September/October 1975): 3-14; and Susan R. Roesch, "The Monetary-Fiscal Mix through Mid-1976," Federal Reserve Bank of St. Louis, Review 57 (August 1975): 2-7.

38. As Hayek puts it, we may find ourselves caught holding onto a "tiger by the tail." See Friedrich A. Hayek, A Tiger by the Tail (London: Institute of Economic Affairs, 1972).

39. The revenue collected by government from inflation is quite high, Friedman having estimated it in excess of $25 billion for 1973. Clearly, the forces of government have much to gain from the Federal Reserve's permitting the monetary expansion, so the nominal independence of the Fed should not be allowed to obscure one's understanding of why the expansion takes place under prevailing monetary institutions. The estimate for 1973 is presented in Milton Friedman, Monetary Correction (London: Institute of Economic Affairs, 1974), pp. 14-15. For a more general treatment of revenue received by government from inflation, see Milton Friedman, "Government Revenue from Inflation," Journal of Political Economy 79 (August 1971): 846-856.

Chapter 9

40. Cf. James M. Buchanan, The Demand and Supply of Public Goods (Chicago: Rand McNally, 1968).

41. On this point, see James M. Buchanan, "Externality in Tax Response," Southern Economic Journal 33 (July 1966): 35-42.

42. For a conceptual and empirical examination of the ability of tax institutions to influence the perceived costs of government, thereby modifying budgetary outcomes, see Richard E. Wagner, "Revenue Structure, Fiscal Illusion, and Budgetary Choice," Public Choice 25 (Spring 1976): 45-61.

43. The so-called "Austrian school" of economists, along with a more specialized tradition in cost theory centering on the London School of Economics in the 1930s, provide notable exceptions. For a general discussion, see James M. Buchanan, Cost and Choice (Chicago: Markham, 1969).

44. For the early treatment of fiscal illusion, see A. Puviani, Teoria della illusione finanziaria (Palermo, 1903).

45. See, for instance, Donald A. Norman, Memory and Attention (New York: Wiley, 1969); and Peter H. Lindsay and Donald A. Norman, Human Information Processing (New York: Academic Press, 1972).

46. Randall Bartlett makes the same point, only he uses a visual rather than an auditory metaphor. In his framework, some tax forms have higher visibility than others. Starting with perfect visibility, taxes can be arrayed in descending order of visibility. In both his analysis and ours, changes in the institutional format for extracting revenues will influence citizen perceptions of the cost of government. See Randall Bartlett, Economic Foundations of Political Power (New York: Free Press, 1973), pp. 92-95.

47. The seminal work on information in a market context is George J. Stigler, "The Economics of Information," Journal of Political Economy 69 (June 1961): 213-225. We view our discussion of fiscal information essentially as an extension of Stigler's analysis of market information. Any differences that might seem to exist are those that are necessary to take account of the salient institutional differences between market choice and fiscal choice. Fiscal choice is subject to greater transactional complexity because price quotations are seldom made. Instead, "prices" are typically embedded within a complex network of economic relationships and are unrelated to the purchase of services from government.

48. This is the fiscal application of one of the general paradoxes or problems of democratic process. If there are large numbers of voters, no one voter has a significant influence on political outcomes. Hence, no voter finds it worthwhile to invest in information, and, in the limit, the individual will not find it advantageous to vote at all. On this, see Anthony Downs, An Economic Theory of Democracy (New York: Harper and Row, 1957); and Gordon Tullock, Toward a Mathematics of Politics (Ann Arbor: University of Michigan Press, 1967).

49. For a generalized, if still preliminary, treatment of the impact of fiscal institutions on fiscal choices in political democracy, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967).

50. David Ricardo, The Principles of Political Economy and Taxation, Works and Correspondence, vol. 1, ed. P. Sraffa (Cambridge: Cambridge University Press, 1951), pp. 244-249. In his discussion of the practical political comparison of the tax and debt alternatives, Ricardo did not, himself, adhere to the equivalence theorem. For a discussion of Ricardo's views in some detail, see Gerald O'Driscoll, "The Ricardian Non-Equivalence Theorem," mimeographed (Ames: Iowa State University, April 1976).

51. The prospect that real-world shifts among financing instruments would generate distributional differences provided the basis for Griziotti's attack on the Ricardian theorem. See B. Griziotti, "La diversa pressione tributaria del prestito e dell' imposta," Giornale degli economisti (1917).

52. For a modern attempt to apply the Ricardian theorem, without reference to Ricardo, see Robert J. Barro, "Are Government Bonds Net Wealth?" Journal of Political Economy 82 (December 1974): 1095-1118. For a criticism of Barro's analysis, see James M. Buchanan, "Barro on the Ricardian Equivalence Theorem," Journal of Political Economy 84 (April 1976): 337-342.

53. For further development, see James M. Buchanan, Public Principles of Public Debt (Homewood, Ill.: Richard D. Irwin, 1958); James M. Ferguson, ed., Public Debt and Future Generations (Chapel Hill: University of North Carolina Press, 1964); James M. Buchanan and Richard E. Wagner, Public Debt in a Democratic Society (Washington: American Enterprise Institute, 1967); and E. G. West, "Public Debt Burden and Cost Theory," Economic Inquiry 13 (June 1975): 179-190.

54. For empirical support of this proposition, developed from an examination of the impact of alternative debt-tax mixes for a set of cities in New York, see Kenneth V. Greene, "An Empirical Test of the Wagner Debt Illusion Hypothesis," in Issues in Urban Public Finance (Saarbrucken: International Institute of Public Finance, 1973), pp. 208-225. Related empirical support is found in Wallace E. Oates, " 'Automatic' Increases in Tax Revenues—The Effect on the Size of the Public Budget," in Wallace E. Oates, ed., Financing the New Federalism (Baltimore: Johns Hopkins Press, 1975), pp. 139-160.

55. Local finance, in contrast to national finance, possesses transferability of encumbrances, at least to the extent that revenues are raised through property taxation and voters are owners of property in the locality. Even in this setting, however, there may be some tendency toward excessive debt creation, for reasons developed in Richard E. Wagner, "Optimality in Local Debt Limitation," National Tax Journal 23 (September 1970): 297-305.

56. We do not propose to review this discussion of inflation as a form of tax. For a sample of this literature, see Milton Friedman, "Government Revenue from Inflation," Journal of Political Economy 79 (July/August 1971): 846-856; Reuben A. Kessel and Armen A. Alchian, "Effects of Inflation," Journal of Political Economy 70 (December 1962): 521-537; and Martin J. Bailey, "The Welfare Cost of Inflationary Finance," Journal of Political Economy 64 (April 1956): 93-110.

57. Quite apart from the largely unperceived "tax on cash" which inflation represents, there is an additional element at work which serves to increase real tax rates, thereby generating automatic increases in budgetary levels. If incomes are taxed at progressive rates, and if such components as the tax base, rate brackets, and provisions for exemptions, deductions, and credits are defined in nominal monetary units, real rates of tax will rise with inflation even with no change in real income. In the absence of overt political action to reduce nominal rates of tax, governmental spending in real terms will necessarily rise. For a development of this point, see James M. Buchanan, "Inflation, Progression, and Politics," in Inflation, Economic Growth and Taxation, Proceedings of the 29th Session (1973), International Institute of Public Finance (Barcelona: Ediciones Alba, S.A., 1975), pp. 45-46. For an empirical examination of the actual extent of such increases in real tax rates, see Charles J. Goetz and Warren E. Weber, "Intertemporal Changes in Real Federal Income Tax Rates, 1954-70," National Tax Journal 24 (March 1971): 51-63. For empirical evidence supporting the thesis of underestimation of taxation that results from inflation, with the result being a rise in public expenditure, see Oates.

58. This simple contrast does not deny that people can come to anticipate changes in the price level, the value of money, and react accordingly in their market transactions. Anticipations of inflation may form more rapidly under the first institution than under the second, but, under both institutions, we would expect to observe shifts in the nominal terms of trade in market transactions. What is different as between the two institutions is the informational setting for public choice.

Chapter 10

59. The seminal exposition of functional finance is Abba P. Lerner, "Functional Finance and the Federal Debt," Social Research 10 (February 1943): 38-51.

60. See Herbert Stein, The Fiscal Revolution in America (Chicago: University of Chicago Press, 1969), pp. 187-190, for a discussion of the change in attitudes toward built-in flexibility which took place during the 1930s.

61. See Stein, pp. 127-128, for a discussion of the emergence of this idea.

62. For a description of the technique used to estimate full-employment surplus, see Keith Carlson, "Estimates of the High-Employment Budget, 1947-1967," Federal Reserve Board of St. Louis, Review 49 (June 1967): 6-14.

63. Taxes and the Budget: A Program for Prosperity in a Free Economy (New York: Committee for Economic Development, 1947). See also Walter W. Heller, "CED's Stabilizing Budget Policy after Ten Years," American Economic Review 47 (September 1957): 634-651.

64. In an argument related to our point here, Lucas has cast doubt upon the ability to use the parameters of econometric models for evaluating alternative public policies. The reason is that the selection of a policy will itself modify the actions of economic agents, thereby altering the behavior implied by the estimated parameters and vitiating the conclusions of the econometric model. See Robert E. Lucas, Jr., "Econometric Policy Evaluation: A Critique," in Karl Brunner and Allan H. Meltzer, eds., The Phillips Curve and Labor Markets (Amsterdam: North-Holland, 1976), pp. 19-46.

65. For a discussion, see Milton Friedman, "The Role of Monetary Policy," American Economic Review 58 (March 1968): 1-17.

66. For a description and discussion of the act, see Committee for Economic Development, The New Congressional Budget Process and the Economy (New York: Committee for Economic Development, 1975); and Jesse Burkhead and Charles Knerr, "Congressional Budget Reform: New Decision Structures" (Paper presented at a conference, "Federal Fiscal Responsibility," March 1976), to be published in a volume of proceedings.

67. Some economists have suggested that the Keynesian-oriented staff of the Congressional Budget Office, created under the 1974 act, may exert a direct influence toward larger deficits rather than toward smaller. Comments by Beryl Sprinkel to this effect were reported in the Washington Post, 5 May 1976, p. D9.

68. The conventional journalistic wisdom on economists' views on budget balance was expressed in Time's report on the economic advisers to the 1976 presidential contenders. The account stated that "Martin Anderson is one of the few economists who still believe that a literally balanced federal budget is possible" (Time, 26 April 1976, p. 54). While we should acknowledge that relatively few of our professional colleagues would now believe that budget balance is desirable, we should indeed be surprised to learn that few consider balance to be possible, unless, of course, the political constraints that we emphasize are incorporated into the prediction.

Chapter 11

69. The concluding clause of the paragraph in which the citation in the text appears goes, "and to promote maximum employment, production, and purchasing power." This wording suggests that the commitment to full employment is not absolute, and the discussion of the trade-off between unemployment and inflation that surfaced in the late 1950s was a response to this perceived ambiguity. What this meant in practice was that full employment was only a relatively absolute absolute.

70. Economic Report of the President, 1962, p. 46. "Okun's Law," which was developed to give a quantitative estimate of the loss from unemployment, is based on this 4-percent measure, for its measure of the loss from unemployment is

L = 3(U - .04)GNP,
where U is the rate of unemployment and GNP is the dollar value of Gross National Product. See Arthur Okun, "The Gap between Actual and Potential Output," in Arthur Okun, ed., The Battle against Unemployment (New York: Norton, 1965), pp. 13-22.

71. For a brief general discussion, see Michael L. Wachter, "Some Problems in Wage Stabilization," American Economic Review 66 (May 1976): 65-66. For a specific analysis of unemployment compensation, see Martin Feldstein, "Unemployment Compensation: Adverse Incentives and Distribution Anomalies," National Tax Journal 17 (June 1974): 231-244.

72. Michael L. Wachter estimated that the rate of unemployment consistent with price-level stability was 5.5 percent in 1975, which he admitted to be a minimal figure. See Wachter, pp. 66-67.

73. Werner Zohlnhöfer has developed a similar point in much more general terms. He argues that a politician or party in opposition to the ruling coalition can never enhance chances of success by lending support to anti-inflationary measures. See Werner Zohlhhöfer, "Eine politische Theorie der schleichenden Inflation," in Schriften des Vereins für Socialpolitik, Gesellschaft für Wirtschafts- und Sozialwissenschaft, N. F. Band 85/1 (1975), pp. 533-555.

74. By common argument, the situation in Great Britain in the late 1970s was even worse than that in the United States. For a set of assessments in 1976, see John Flemming et al., Catch 76, Occasional Paper no. 47 (London: Institute of Economic Affairs, 1976). Also, see Peter Jay, Employment, Inflation, and Politics, Occasional Paper no. 46 (London: Institute of Economic Affairs, 1976).

75. As noted earlier, the basic paper is A. W. Phillips, "The Relation between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861-1957," Economica 25 (November 1958): 283-299. In this article, the trade-off was between wage inflation and unemployment. This relation was subsequently transformed into the more familiar relation between price inflation and unemployment. The American discussion was inaugurated by the famous Samuelson-Solow paper. See Paul A. Samuelson and Robert M. Solow, "Analytical Aspects of Anti-Inflation Policy," American Economic Review 50 (May 1960): 177-194.

76. A survey of alternative perspectives toward the Phillips curve is presented in Thomas M. Humphrey, "Changing Views of the Phillips Curve," Federal Reserve Bank of Richmond, Monthly Review 59 (July 1973): 2-13.

77. See, for instance, Milton Friedman, "The Role of Monetary Policy," American Economic Review 58 (May 1968): 1-17.

78. A clear, early presentation of this theme can be found in Friedrich A. Hayek, Prices and Production, 2d ed. (London: Routledge and Kegan Paul, 1935). A general exposition is contained in Gottfried Haberler, Prosperity and Depression, 5th ed. (London: Allen & Unwin, 1964), pp. 29-72. A recent, formal development of this possibility occurs in Robert E. Lucas, Jr., "An Equilibrium Model of the Business Cycle," Journal of Political Economy 83 (December 1975): 1135-1137.

79. Many of the strictures against end-state norms of justice raised by Robert Nozick might readily be translated into strictures against the policy-oriented discussion of "full employment" in the post-Keynesian period. See Robert Nozick, Anarchy, State, and Utopia (New York: Basic Books, 1974).

80. See the careful and thorough documentation of this point in Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press, 1963), pp. 299-419.

Chapter 12

81. For a 1975 statement in support of these efforts, see James M. Buchanan and Richard E. Wagner, "Deficit Spending in Constitutional Perspective," in Balancing the Budget, Hearings before the Subcommittee on Constitutional Amendments, Committee of the Judiciary, United States Senate, 94th Congress, 1st Session, 23 September 1975 (Washington: U.S. Government Printing Office, 1975), pp. 61-64.

82. In the discussion prior to the enactment of the budget reform legislation of 1974, William Niskanen advanced a proposal that would have required that tax rates be automatically increased if Congress failed to keep spending within its own chosen target levels. See William Niskanen, Structural Reform of the Federal Budget Process (Washington: American Enterprise Institute, 1973).

83. For a general discussion of the residual adjustment in budgets, as these affect fiscal choices, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), Chs. 7 and 8 especially.

84. One thing to be avoided in any variant of an automatic adjustment scheme would seem to be attempts to protect outlays on salaries for legislative and bureaucratic personnel. In fact, a strong case could be made for requiring disproportionate adjustment in this component of the federal budget, since this would provide an indirect means of encouraging compliance with the constitutional norm for maintaining overall balance in the fiscal account. It would be difficult to think of much legislative or bureaucratic agitation to exceed budget-balance guidelines if the penalties were known to include explicit reductions in governmental salaries.

85. Such an approach to restoring a balanced budget is also advocated in Raymond J. Saulnier, "Federal Spending, Budget Deficits, Inflation and Jobs," Tax Review 37 (June 1976): 21-24.

86. The complementary of rules for steady monetary growth and for a continually balanced budget, along with supporting argument for both, is developed in Robert E. Lucas, Jr., "An Equilibrium Model of the Business Cycle," Journal of Political Economy 83 (December 1975): 1113-1144.

87. For a specific discussion of alternative monetary constitutions, see Leland B. Yeager, ed., In Search of a Monetary Constitution (Cambridge: Harvard University Press, 1962).

88. A widely acknowledged fact of political history is the increasing difficulty of dislodging incumbent members of Congress. This has often been attributed to the costs of entry and to similar financial barriers. Our argument suggests that a supplementary cause well may lie in the illusion that incumbent modern legislators do avoid facing up to scarcity constraints.

End of Notes

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