This is an ideal time to look at Friday's GDP data and ask the question "what role does the government have in affecting this data?" GDP is big. It is THE measure of the size of the economy. The analysis is that part of the government is trying to expand the economy and part is trying to contract the economy. Moreover whenever there is such a tug of war one of those parties is destined to always win.
The United State government gets involved in the economy in three manners: regulatory, monetary and fiscal. Regulatory has to do with such as minimum wage, working conditions, FDA, OSHA etc. While these regulations are all of import they have little to do with the cycles which we are so fond of discussing.
Back up a Minute Here
There is some common perception that somehow the Federal Government runs the economy and creates jobs and yada, yada, yada. This is simply not true. Politicians make this an issue. They make high profile speeches during campaigns stating that they have created jobs or the other guy has not. The fact is that this is total hogwash. These speeches serve two purposes: 1) they confuse people about what politicians are responsible for and 2) they confuse people about how the economy functions.
The economy consists of a coming together of business (capital and management) with workers and customers. Business is the crux of the economy. This is not to say that business is the economy; it it the crossroads of economic activity. Domestic business has changed a great deal in the past few decades. Ours is no longer a goods producing economy where the jobs are at factories but rather a service producing economy where the jobs are in offices. The "machines" are computers, faxes and copiers. The jobs which are created are created by business not by government. Jobs growth requires investment from business and training and education from workers. Lamenting the loss of jobs to businesses in other countries is a futile activity. We live in a "smaller world" where low cost communications and transportation and the efficiency of retail chains such as Wal-Mart have altered things. The benefit is low prices. But, as the Home Depot slogan says, "Low prices are just the beginning." The downside is the loss of domestic manufacturing jobs.
To a very large extent, changes in the structure of the economy are the result of technological forces and worldwide macroeconomic forces such as globalization.
How the Government Is Involved
Significant government involvement in the economic process involves monetary and fiscal policy. Monetary policy is the business of the Federal Reserve. The Fed controls interest rates and the money supply. It controls short term rates essentially by caveat. It does not really get involved in the short term market but, in effect, tells everyone else what the yield on the 1 year Treasury should be and what prime should be.
The Fed maintains its control of the money supply by buying or selling Treasuries. When it sells Treasuries it takes money out of supply. When it buys Treasuries it increases money supply. Money supply needs to change in response to 1) seasonal variations in spending (the money supply needs to be larger during the Christmas shopping season and 2) expanding GDP. Money supply should move in step with GDP. Increase in GDP necessitate increases in the money supply. It might be easier to see that money supply needs to be tied to Retail Sales and that Retail Sales must have strong correlation to money supply.
Money supply goes hand in hand with rates. Note that at present the Fed has been increasing short term rates. This has the effect of slowing the rate of growth of the economy. The Fed is not doing this for any sinister purpose. It is doing this to abate inflation. The healthy economic growth we have had for the past 3+ years has the lingering possibility of creating unwanted inflation and higher rates should slow the rate of growth and help to contain inflation.
Fiscal policy is not under the control of the Federal Reserve. It is instigated by the President and Congress with its policies regarding taxes and spending. At present with one party in control of the White House and Congress fiscal policy is largely in the hands of the White House. They lowered taxes which had the effect of expanding the economy in the short term (more money in the hands of consumers) and increased spending which is also expansionary. It is to this extent that the government does have any effect on creating jobs. The increase in expenses was largely in reaction to 9/11 and the contemporary mini-recession.
Making no judgment of the worth of these activities per se it is important to keep one's opinions untangled from ones perception of the effect that this has on the economy. That spending is expansionary. It increases GDP. This is not to say that increased spending and lower tax rates are, in the long, a good idea. That is a more complicated topic. The point is that they are expansionary in the short term. We might find that, in the long run, we regret the price of the deficits which this policy has created.
My own view about fiscal policy is spelled out here. Essentially it says: let Congress and the administration do the spending part of fiscal policy but let decisions about tax rates and deficits up to a third party similar in constitution to the Federal Reserve. It would be wonderful if our elected officials were in total control of fiscal policy but it is my opinion that this system simply does not induce healthy fiscal decisions. It appears that the motivation to adopt responsible fiscal policy takes a back seat to political concerns. If we are going to allow revenue to fall below expenses for the purpose of economic expansion that I would prefer than an entity with the long-term vision and one which does not have to answer to the electorate determine that policy.
So at present we have fiscal policy which is expansionary and monetary policy which is contractionary. Looking at the data today it becomes more apparent that fiscal policy as created by this administration was expansionary but that the effective lifetime of that expansion is short. Tax decreases translate into something like one to one increases in GDP. They boost GDP by a certain amount but that boost is not exponential. On the other had the Federal Reserve is in this for the long haul and it is their tight monetary policy which is quite deliberately slowing GDP growth.
The issue as to whether lower taxes and deficits contribute enough to the economy to make them wise should be left to someone other than politicians. One note at the end here. I am not stating that having one part of the government try to expand the economy while another is trying to contract it is utter foolery. While it would certainly not be my way of running things I grant that perhaps this is a form of "checks and balances." I am saying that, on the surface, it seems to be less than ideal. It would make more sense to me if monetary and fiscal policy were not engaged in a tug of war. My thesis here is implied in the last paragraph. The Fed will always win these tugs-of-war. I emphasize here that these are my opinions on what is indeed a complex topic.