Does the US have a Revenue or Spending Problem?

[Professor S]

Discuss.

[Bond]

So, I think it is mostly a spending problem, and a bit of a revenue problem. The revenue aspect stems mostly from the economy being terrible. If the economy is able to recover in the coming years, revenue should increase proportionately. Also, as we've discussed before, tax rates and revenue are not correlated. So, the old line politicians often tout that "increasing tax rates increases revenue" is patently false.

I think we need to look at revenue as have two primary functions: 1) to raise money for the government and 2) to curb inflation. The Federal Reserve could theoretically print money ad nauseum and eliminate the need for taxation, but this would cause hyper-inflation.

As an observation, the more I've been thinking about it, the Federal Reserve throws a bit of a wrench into Austrian economics ... I think the basic points of Hayek and Mises still hold, but we do have to account for the Reserve's ability to legitimately create money out of thin air that does not suffer extreme inflation -- it's impressive.

[Professor S]

I agree that the Fed has done a pretty good job of balancing the opposing inflationary forces of cheap money and depressed markets, but IMO the side effect is slow growth. The cheaper money is, the less incentive banks have to lend, and the greater the uncertainty when businesses consider investing in themselves. This is why I have always maintained that the Fed is an effective backstop to a crash, but a terrible stimulator.

Honest question: Do you think inflation would still be low if Europe wasn't in the state it is in? Isn't the value of money in a fiat system relative to other currencies and markets?

[Bond]

That's fair, but I honestly don't know enough about how all of those factors affect one another to say any more.

The Federal Reserve used to target a "range" of inflation (I think around 1.7-2.2%), but Bernanke set a specific target rate for the first time earlier this year at 2%. So far the inflation rate has hovered around the target.

I think the Fed is actually doing an okay job with inflation, especially when you consider the crazy alternative, i.e. Paul Krugman: http://www.nytimes.com/2012/04/29/ma...1&ref=magazine