Treasury View
Encyclopedia
In macroeconomics
, particularly in the history of economic thought
, the Treasury view is the assertion that fiscal policy
has no effect on the total amount of economic activity and unemployment
, even during times of economic recession
. This view was most famously advanced in the 1930s (during the Great Depression
) by the staff of the British Chancellor of the Exchequer
. The position can be characterized as:
In his 1929 budget speech, Winston Churchill explained, "The orthodox Treasury view ... is that when the Government borrow[s] in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise, and in the process raises the rent of money to all who have need of it."
Keynesian economists
reject this view, and often use the term "Treasury view" when criticizing this and related arguments. The term is sometimes conflated with the related position that fiscal stimulus has negligible impact on economic activity, a view that is not incompatible with mainstream macroeconomic theory.
, many economists (most prominently John Maynard Keynes
) tried to persuade governments that increased government spending would mitigate the situation and reduce unemployment. In the United Kingdom
, the staff of the Chancellor of the Exchequer, notably Ralph George Hawtrey
and Frederick Leith-Ross
, argued against increased spending by putting forward the "Treasury view". Simply put, the Treasury view was the view that fiscal policy could only move resources from one use to another, and would not affect the total flow of economic activity. Therefore, neither government spending nor tax cuts could boost employment and economic activity. This view can historically be traced back to various statements of Say's law
.
Keynes argued against this position, and particularly in The General Theory of Employment, Interest, and Money, provided a theoretical foundation for how fiscal stimulus can increase economic activity during recession
s.
Opinions are currently sharply divided on the Treasury view, with different schools of economic thought holding contradicting views. Many in the "freshwater" Chicago school of economics advocate a form of the Treasury view, whereas economists from saltwater school
s reject the view as incorrect.
A number of prominent financial economists (including Eugene Fama
) have recently advocated the strong form of this view – that of no possible impact. However, it is categorically rejected by Keynesian macroeconomics, which holds that economic activity depends on aggregate spending (at least in the short run). It is related to, and at times equated with, theories of Say's law
, Ricardian equivalence
, and the Policy Ineffectiveness Proposition
.
Noted macroeconomists such as Milton Friedman
and Robert Barro
have advocated a weak form of this view, that fiscal policy has temporary and limited effects. Such a view is not incompatible with Keynesian macroeconomics.
(NIPA) to say that, as a matter of accounting, government spending must come from somewhere, and thus has no net impact on aggregate demand
, unemployment, or income.
Positions on this argument are far apart: advocates of the accounting argument for the Treasury view argue that as a matter of accounting (by definition) fiscal stimulus cannot have an economic impact, while critics argue that this argument is fundamentally wrong-headed and mistaken.
A Keynesian reply, by Paul Krugman
, is that
That is, NIPA accounting equations hold for a fixed GDP: the point of fiscal stimulus is to change GDP, and that changes in government spending are only exactly offset by decreases in other spending or investment if GDP is unchanged. Keynesians argue that fiscal stimulus can increase GDP, thus making this point moot.
Another Keynesian reply, by Brad DeLong, is that these make assumptions about saving and investment, and ignore basic monetary economics, notably velocity of money
: if (for a given money supply) velocity of money increases, (nominal) GDP increases, as GDP = Money Supply * Velocity of Money: a dollar of government spending need not crowd out a dollar of private spending, either as an accounting matter or as a behavioral matter, as it may increase velocity of money.
in the converse context (fiscal restraint via tax increases having a braking effect, as opposed to fiscal stimulus having a stimulating effect) begins with the NIPA argument above, then continues from the accounting to an economic model:
specifically:
concluding:
and instead advocating monetary policy
as the bottom line:
This analysis, while disputed by Keynesians (who argue that the effects of fiscal stimulus are more significant than Friedman argues), is considered a legitimate approach, and not dismissed out of hand as wrong-headed.
Macroeconomics
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...
, particularly in the history of economic thought
History of economic thought
The history of economic thought deals with different thinkers and theories in the subject that became political economy and economics from the ancient world to the present day...
, the Treasury view is the assertion that fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
has no effect on the total amount of economic activity and unemployment
Unemployment
Unemployment , as defined by the International Labour Organization, occurs when people are without jobs and they have actively sought work within the past four weeks...
, even during times of economic recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
. This view was most famously advanced in the 1930s (during the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
) by the staff of the British Chancellor of the Exchequer
Chancellor of the Exchequer
The Chancellor of the Exchequer is the title held by the British Cabinet minister who is responsible for all economic and financial matters. Often simply called the Chancellor, the office-holder controls HM Treasury and plays a role akin to the posts of Minister of Finance or Secretary of the...
. The position can be characterized as:
In his 1929 budget speech, Winston Churchill explained, "The orthodox Treasury view ... is that when the Government borrow[s] in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise, and in the process raises the rent of money to all who have need of it."
Keynesian economists
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
reject this view, and often use the term "Treasury view" when criticizing this and related arguments. The term is sometimes conflated with the related position that fiscal stimulus has negligible impact on economic activity, a view that is not incompatible with mainstream macroeconomic theory.
History
In the late 1920's and early 1930s, during the height of the Great DepressionGreat Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
, many economists (most prominently John Maynard Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
) tried to persuade governments that increased government spending would mitigate the situation and reduce unemployment. In the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
, the staff of the Chancellor of the Exchequer, notably Ralph George Hawtrey
Ralph George Hawtrey
Sir Ralph George Hawtrey was a British economist, and a close friend of John Maynard Keynes.He studied at Eton, then Cambridge, where he graduated in 1901 with first-class mathematics honours. He spent the rest of his working life in the study of economics. Between 1904 and 1945 he worked in the...
and Frederick Leith-Ross
Frederick Leith-Ross
Sir Frederick William Leith Ross was chief economic adviser to the UK government from 1932 to 1945.-Biography:Leith Ross graduated with a double first from Balliol College, Oxford...
, argued against increased spending by putting forward the "Treasury view". Simply put, the Treasury view was the view that fiscal policy could only move resources from one use to another, and would not affect the total flow of economic activity. Therefore, neither government spending nor tax cuts could boost employment and economic activity. This view can historically be traced back to various statements of Say's law
Say's law
Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...
.
Keynes argued against this position, and particularly in The General Theory of Employment, Interest, and Money, provided a theoretical foundation for how fiscal stimulus can increase economic activity during recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
s.
Opinions are currently sharply divided on the Treasury view, with different schools of economic thought holding contradicting views. Many in the "freshwater" Chicago school of economics advocate a form of the Treasury view, whereas economists from saltwater school
Saltwater school (economics)
In economics, the freshwater school comprises macroeconomists who, in the early 1970s, challenged the prevailing consensus in macroeconomics research. Key elements of their approach was that macroeconomics had to be dynamic, quantitative, and based on how individuals and institutions make...
s reject the view as incorrect.
A number of prominent financial economists (including Eugene Fama
Eugene Fama
Eugene Francis "Gene" Fama is an American economist, known for his work on portfolio theory and asset pricing, both theoretical and empirical. He is currently Robert R...
) have recently advocated the strong form of this view – that of no possible impact. However, it is categorically rejected by Keynesian macroeconomics, which holds that economic activity depends on aggregate spending (at least in the short run). It is related to, and at times equated with, theories of Say's law
Say's law
Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...
, Ricardian equivalence
Ricardian equivalence
The Ricardian equivalence proposition is an economic theory holding that consumers internalize the government's budget constraint: as a result, the timing of any tax change does not affect their change in spending...
, and the Policy Ineffectiveness Proposition
Policy Ineffectiveness Proposition
The Policy Ineffectiveness Proposition is a new classical theory proposed in 1976 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations...
.
Noted macroeconomists such as Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
and Robert Barro
Robert Barro
Robert Joseph Barro is an American classical macroeconomist and the Paul M. Warburg Professor of Economics at Harvard University. The Research Papers in Economics project ranked him as the 4th most influential economist in the world as of August 2011 based on his academic contributions...
have advocated a weak form of this view, that fiscal policy has temporary and limited effects. Such a view is not incompatible with Keynesian macroeconomics.
Arguments for
Arguments equivalent to the Treasury view are frequently rediscovered independently, and are often in turn criticized by Keynesian macroeconomists.Accounting
One line of argument is to use the accounting equations in the National Income and Product AccountsNational Income and Product Accounts
The National Income and Product Accounts are part of the national accounts of the United States. They are produced by the Bureau of Economic Analysis of the Department of Commerce...
(NIPA) to say that, as a matter of accounting, government spending must come from somewhere, and thus has no net impact on aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
, unemployment, or income.
Positions on this argument are far apart: advocates of the accounting argument for the Treasury view argue that as a matter of accounting (by definition) fiscal stimulus cannot have an economic impact, while critics argue that this argument is fundamentally wrong-headed and mistaken.
A Keynesian reply, by Paul Krugman
Paul Krugman
Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
, is that
- ...[this] commits one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship.
That is, NIPA accounting equations hold for a fixed GDP: the point of fiscal stimulus is to change GDP, and that changes in government spending are only exactly offset by decreases in other spending or investment if GDP is unchanged. Keynesians argue that fiscal stimulus can increase GDP, thus making this point moot.
Another Keynesian reply, by Brad DeLong, is that these make assumptions about saving and investment, and ignore basic monetary economics, notably velocity of money
Velocity of money
300px|thumb|Similar chart showing the velocity of a broader measure of money that covers M2 plus large institutional deposits, M3. The US no longer publishes official M3 measures, so the chart only runs through 2005....
: if (for a given money supply) velocity of money increases, (nominal) GDP increases, as GDP = Money Supply * Velocity of Money: a dollar of government spending need not crowd out a dollar of private spending, either as an accounting matter or as a behavioral matter, as it may increase velocity of money.
Economic model
An argument advanced by Milton FriedmanMilton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
in the converse context (fiscal restraint via tax increases having a braking effect, as opposed to fiscal stimulus having a stimulating effect) begins with the NIPA argument above, then continues from the accounting to an economic model:
- To find any net effect on private spending, one must look farther beneath the surface.
specifically:
- [S]ome of the funds not borrowed by the Federal government may be added to idle cash balances rather than spent or loaned.
- In addition, it takes time for borrowers and lenders to adjust to reduced government borrowing.
concluding:
- However, any net decrease in spending from these sources is certain to be temporary and likely to be minor.
and instead advocating monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
as the bottom line:
- To have a significant impact on the economy, a tax increase must somehow affect monetary policy–the quantity of money and its rate of growth.
This analysis, while disputed by Keynesians (who argue that the effects of fiscal stimulus are more significant than Friedman argues), is considered a legitimate approach, and not dismissed out of hand as wrong-headed.
Proponents
- Daniel Mitchell of the Cato InstituteCato InstituteThe Cato Institute is a libertarian think tank headquartered in Washington, D.C. It was founded in 1977 by Edward H. Crane, who remains president and CEO, and Charles Koch, chairman of the board and chief executive officer of the conglomerate Koch Industries, Inc., the largest privately held...
, a supply-side economist, quoted by Caroline Baum in Keynes Revival Makes Cato a Lonely Hearts Club - Obama’s Job-Creation Program Flunks Basic Math, Caroline Baum, BloombergBloomberg L.P.Bloomberg L.P. is an American privately held financial software, media, and data company. Bloomberg makes up one third of the $16 billion global financial data market with estimated revenue of $6.9 billion. Bloomberg L.P...
- Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?, by John H. CochraneJohn H. CochraneJohn Howland Cochrane is an economist, specializing in financial economics and macroeconomics. He is the AQR Capital Management Professor of Finance at the University of Chicago Booth School of Business.- Career :...
, Myron S. Scholes Professor of Finance, University of Chicago Booth School of Business - Eugene FamaEugene FamaEugene Francis "Gene" Fama is an American economist, known for his work on portfolio theory and asset pricing, both theoretical and empirical. He is currently Robert R...
, Bailouts and Stimulus Plans
Other
- Background on "fresh water" and "salt water" macroeconomics, by Robert Waldmann