The opacity on the implications of its construction, and ambiguity regarding its status of neutral, technical instrument, seem to be essential elements of its origin and fortune.
Much like the oracles of old, numbers and statistics exert the charm of obscure utterances that have the power to generate a Truth whose logic escapes most minds. So it is for the Cyclically Adjusted Budget that links the actual government budget to the economic trend. Such exercises in estimation are used by most institutions and governments, with significant influence on policy and on public perception of fiscal issues.
Like all statistical tools, it needs to be handled with care. But most people seem to be unaware of the limits in its applicability and of the degree of arbitrariness it assumes in the definition of policy targets – such as the “optimal” level of unemployment.
Unsurprisingly, its formulation has changed dramatically over time, adapting to historical circumstances and political preferences. The greatest make-over occurred during the late seventies and the Reagan years in the US, when it turned from a tool conceived to support full employment policies into a surveillance instrument for budgetary reduction. In this latest form, it became a cornerstone of the European Union’s fiscal policy procedures in 2005 and, to this day, it remains the principal instrument for policy guidance in the evolving European fiscal framework.
But a certain opacity on the implications of its construction and ambiguity regarding its status of neutral, technical instrument seem to be essential elements of its origin and fortune. Those are strictly connected with the awareness acquired over the thirties and forties that the composition of the fiscal action can be a crucial element of political mediation that defines the state-market relationship. Along with this awareness came the discovery that rigid compliance with estimated budget constraints can convey, unaccounted for, a great deal of flexibility toward vested economic interests.
It was then that American elites started discovering the advantages of deficit spending. Not of any deficit spending, of course, rather a specific budget composition that could support growth and preserve their earnings and wealth from substantial taxation.
Since this was the late New Deal period, however, this meant walking a thin line between the social democratic left – favorable to strong business taxation, nationalizations, and further social equity – and the authoritarian, as well as protectionist, sympathies of vast parts of the rest of the business community.
One business group in particular, the Committee for Economic Development, was especially active and relevant since its creation in 1942, developing some popular policy plans, funding and spreading the results of relevant research, and directly intervening in the public debate.
In an effort to “liberat[e] high employment policies from the stigma of socialism and, at the same time, defang[…] them of their socialist potential,” it came to selectively embrace Keynes’ revolutionary ideas on fiscal policy and thus contribute to shaping the quasi-official doctrine of the American Keynesianism. Its successful operation also produced a long lived set of technical tools and practices to institutionalize and secure minority preferences.
Among those, was the Cyclically Adjusted Budget, called High Employment Budget in the original CED’s plan of 1944, and Full Employment Surplus in the following version developed by John F. Kennedy’s Council of Economic Advisers.
The idea behind the CAB is to separate the structural component of the budget, that corresponds to what the latter would be in some ideal output conditions, called potential output, and the cyclical component, that depends on how far we stand from that ideal condition. This way the effect on the budget balance of the “net” fiscal effort of the government can be estimated separately from the effects of output fluctuations on tax revenues and social expenditures. But the outcome of this estimation depends greatly on how the cycle and potential output are defined. Obviously, across time and schools of thought, this has been done very differently, either as a target of fiscal action or as a natural optimum to which the economy autonomously is said to be attracted. In the first option, a structural deficit results from too small a fiscal expansion, in the second from too small a contraction.
The first definition applies to the Committee for Economic Development’s and the Kennedy era Keynesian versions, the latter especially using a 4% unemployment rate as the target. The second instead has prevailed since the eighties, when a consensus on its methods of calculations also emerged, essentially relying on univariate statistical de-trending techniques such as the Hodrick-Prescott filter. These all produce ex-post averages of the actual output that closely track the latter (Palumbo, 2013). Hence, not only does potential output turn out to be the normal output, but the definition of this normal condition becomes one that ex-post justifies the performance of the economy, giving a near free pass to the effects of fiscal policy itself.
This implication is shared by another popular method that is now used by most governmental and international institutions including the European Commission: the production function method. This formulation is heavily reliant on the same statistical filtering techniques and similarly based on the idea that economic growth is supply driven. However, it differs from the purely statistical method because it permits explicit consideration of the assumed effects of institutional and supply-side measures such as the degree of unionization, market structure, pension reforms and social incentives, political – even electoral – reforms etc.
As a result of these methods, as Alain Parguez says, we always are in full employment by decree, regardless of what actual figures show. Moreover, specific fiscal actions, as well as institutional reforms, can be presented as the only way to increase the economies’ potential and thus succeed in the public debates.
The opacity of the instrument is thus enhanced by its ad hoc construction that allows for unaccountable degrees of flexibility for specific interests and conveys political reforms to national governments and electorates.
This poses ever more urgently the issue of democratic control over economic policies that have immense social and political repercussions that are not adequately represented in official narratives nor in the technical models that the institutions use.
Some in the EU call for a redefinition of the estimate’s formula in a more growth-friendly fashion, but this would imply only a slight re-orientation of the economic interests that for which the Commission accounts. And indeed recently, just like in forties, it seems that the governments’ desire for stronger military and intelligence capabilities has a chance to successfully trigger such re-orientation.
Of course, this would hardly go in the direction of an emancipation of the discourse on fiscal policy from pseudo-technocratic dictat that would instead imply the admission that the economic measures of the governments can serve any political priority one community decides to take on. In other words, institutions should dismiss the technocratic veil and undertake responsibility for – as an example – ignoring the claims of unemployed and precarious workers for more economic security and equity, or of students for more plural and accessible education.
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* The theme of this article has been originally treated in the Paper: "The Cyclically Adjusted Budget: History and Exegesis of a Fateful Estimate (Institute for Nnew Economic Thinking). http://ineteconomics.org/ideas-papers/research-papers/the-cyclically-adjusted-budget-history-and-exegesis-of-a-fateful-estimate [2]