Thursday, April 15, 2010

Contradictory Fiscal Policy

The federal government cannot create prosperity by spending funds that it does not have. It can, however, spend us into poverty by taking dollar balances from highly productive individuals and their business entities, through borrowing or taxing. This process of transferring these assets from income and wealth generators to other government applications has profound economic consequences....contrary to conventional wisdom, monumental government spending produced less growth, and lowered both standards of living and inflation. Why does this occur, and will the prospective budget deficits change that history? The answer boils down to the application of mathematics to economic theory....A zero government expenditure multiplier means that deficit spending only provides a transitory boost to the economy. Deficit spending initially raises GDP, but then the effect dissipates and later is reversed as the financial resources available to the private sector are reduced.
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History therefore suggests that cutting taxes tends to boost GDP while raising taxes has the opposite effect. Economic theory suggests that increased government spending can boost economic activity for a time, but the additional borrowing and subsequent tax increases reverse that short-term boost, resulting in lower total output for the economy. The mathematics of these two variables, spending and taxes, suggest the inevitability of a contractionary outcome if there is a massive shift in funds from the private to the public sector.

From Hoisington Management's latest commentary. See the full report.