Myth: Presidents are responsible for the economy's performance.
Fact: Presidents are at the mercy of the business cycle.
When it comes to the economy, presidents are at the mercy of the business cycle. Often their fortune (or misfortune) with the economy depends on what happened in the previous administration. There are tools to influence the business cycle, but the President has almost no control over them. At least in economic terms, the most powerful person in the United States is the Chairman of the Federal Reserve Board.
In all truth, presidents probably have the least control over the economy of any major government player. The belief that presidents deserve blame for recessions or credit for recoveries is an economic myth. A very popular myth, to be sure, but one that no mainstream economist takes seriously.
At the heart of the economy's performance lies the business cycle. For reasons which are still debated, the economy has a natural tendency to expand and contract - otherwise known as recoveries and recessions. This has been going on for centuries, at irregular intervals that economists cannot yet predict. However, one generalization about the business cycle is known. The economy grows in the long run, thanks to the growing population and rising productivity per worker. This means that expansions tend to be longer than contractions. Also, the deeper the recession, the steeper the recovery. The deepest contraction in U.S. history was the Great Depression (1929 to 1933); the steepest recovery was the New Deal and World War II (1934 to 1945). Consider:
Year %Change in GNP President -------------------------------- 1930 - 9.4% Hoover 1931 - 8.5 Hoover 1932 -13.4 Hoover 1933 - 2.1 Hoover/Roosevelt 1934 + 7.7 Roosevelt 1935 + 8.1 Roosevelt 1936 +14.1 Roosevelt 1937 + 5.0 Roosevelt 1938 - 4.5 Roosevelt 1939 + 7.9 Roosevelt
Under Hoover, the economy shrank an average of -8.4 percent a year;
under Roosevelt, it grew 6.4 percent. (It grew even faster during World
War II, roughly doubling in size.) This relationship between the size of
recessions and recoveries can again be seen in the Reagan years. The recession
of 1982 was the worst since World War II, a contraction of -2.2 percent.
And this was followed by an unusually long, seven-year expansion that averaged
a robust 3.7 percent a year. The point of these examples is to show that
a president's "handling" of the economy is often a matter a sheer
luck; any expansion experienced under his term in office is largely predetermined
by the severity of the recession that preceded him.
This does not mean that the government does not have tools to influence the business cycle. It's just that presidents do not have access to most of them.
The most powerful person in the United States, at least in economic terms, is the Chairman of the Federal Reserve Board. He controls the size of the nation's money supply (through interest rates and other methods), which has a profound influence on the business cycle. By contracting the money supply, he can create a recession, by removing the dollars that would normally cover the financial transactions between customers and businesses. This drives up unemployment, but it also has a positive effect: it reduces inflation, by causing businesses to lower their prices, and workers their wage demands, to stay working through tough times.
On the other hand, expanding the money supply helps expand the economy. Businesses have more money to hire workers, and customers have more money to spend on goods, so unemployment falls whenever the Fed pumps more money into the economy. However, there is also a negative effect: it tends to create inflation. Why? Suppose that the Fed expands the money supply by 5 percent a year. If no one changes their prices, then the nation's productivity should expand 5 percent a year -- the result of more financial transactions being made possible. But suppose that businesses come to expect the 5 percent monetary expansion every year. It's in their interest simply to raise their prices 5 percent -- that way they make the same amount of extra money without having to work for it. Thus, in order to expand productivity, the Fed has to expand the money supply by 10 percent the next year -- but eventually businesses come to expect that too. The result can be runaway inflation of 20, 100, 5,000 percent.
The role of the Federal Reserve, therefore, is to find the right balance. It seeks to expand the money supply just fast enough to avoid high unemployment, but not so fast as to create inflation. Often it's work is counter-cyclical, or in opposition to the business cycle. It expands the money supply during recessions, and contracts it during recoveries, to keep both unemployment and inflation in line.
The importance of the Fed cannot be understated. With a few phone calls, the Fed Chairman can create a crushing recession or runaway inflation in a very short period of time. So powerful is the Fed's role that it has completely eliminated the depression from the American economic experience. Before World War II, we suffered eight depressions; since World War II, we have suffered none.
The decisions of the Fed are called monetary policy. There is another way to influence the business cycle: fiscal policy, which is conducted by Congress and, superficially, the president. Much like the Fed, Congress can either pump money into the economy or take it out, by varying its level of borrowing and spending. For example, the Great Depression ended when the U.S. government began massive borrowing and spending on defense in preparation for World War II. The massive influx of dollars into the economy not only eradicated the nation's huge unemployment problem, but also fueled the greatest economic boom in U.S. history.
It should be stressed that fiscal policy only expands the economy when the government spends borrowed money. When Congress runs a balanced budget, it really doesn't matter how much it taxes and spends, at least from an expansionary viewpoint. Historically, the government has run only small deficits during peacetime, allowing the Fed to exercise the most control over the money supply. The 1980s, with their mushrooming peacetime deficits, were a notable exception. But even then, fiscal policy did not even approach the profound influence that monetary policy exerted over the economy.
Fiscal policy is less effective than monetary policy for another reason as well. Whereas the Chairman of the Fed has only to make a few phone calls to turn the economy on a dime, the government must take long, slow and uncertain action. Suppose the president wants to pass a budget filled with deficit spending. First he has to campaign to get the nation behind it. Then he has to make deals and twist arms in Congress to win support for it. If either of these efforts fail, then his budget won't get passed at all. If he is lucky enough to win plausible support, then the budget must be debated in Congress. Members of Congress will make extensive and profound changes to his original budget proposal. Lobbyists will make further changes in conference committee. (The power of lobbyists is not to be underestimated -- their control over the budget is near absolute.) When the final budget is passed, it often bears little resemblance to what the president requested. Then the bill has to be put into effect; this happens in next fiscal year. Bids for government projects must be received and evaluated, contracts awarded, and implementation begun. The effects of fiscal spending may take years to have an effect on the economy.
In recent decades, the president has been relegated to an increasingly minor role in fiscal policy. If Congress is controlled by the other party, then he even becomes a mere figurehead. For example, House Democrats declared seven of Reagan's eight budgets "Dead on Arrival" upon submission. Reagan lobbied Congress, and not Congress Reagan, for the final result. The same problem confronted Bill Clinton when the Republicans took over Congress in 1994. The only real power that Clinton had was the threat of the veto; he could block legislation, but he couldn't actively shape it. And Congress has literally thousands of staff and lobbyists working on the budget; the president only has a small office. Congress dominates the budget process.
Which begs the question: what, exactly, can a president do to influence the economy? His role in determining monetary policy is limited to nominating the members of the Federal Reserve Board. His role in determining fiscal policy is limited to cheerleading budgets through Congress. Sometimes, presidents have promoted projects that have long-term economic impact. Eisenhower, for example, oversaw the interstate highway program, one of the most far-reaching economic endeavors in U.S. history. But it took years, even decades, for the full impact of this program to unfold. Likewise, Clinton's "Reinventing government" project is computerizing the federal bureaucracy and cutting the number of federal employees in an effort to reduce and improve government. But again, the full effects of these programs will not be felt until well after Clinton leaves office.
So the belief that presidents are to blame for the economy, especially the current economy, is regrettably uninformed. Unfortunately, it is a belief that many Americans share. Carter was evicted by the voters for a "misery index" that was really beyond his control; Bush was also fired for a recession that just happened to occur in the middle of his re-election campaign. Neither deserved his fate on those grounds alone.
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