Komla D. Dzigbede
This essay reviews recent scholarship in American economic policymaking. It focuses on scholarly work from 2012 to 2015 and considers three main streams of research. The first concerns how, amidst the lingering effects of the Great Recession, monetary and fiscal policy variables interplay to affect policy outcomes such as employment and income. The second stream relates to the politics of regulation and spans several aspects of regulatory governance such as enforcement and compliance, regulatory arbitrage in financial markets, and the role of U.S. regulatory regime structures as standards of best practice in global contexts. The third stream of research focuses on the dynamics of institutional relationships in the policy process and explores how policy narratives influence policy outcomes, how the media engages and alters political attention, and how interest groups and lobbyists shape policy decisions. The final section provides directions for future research and assesses the extent to which these frontier issues in economic research could shape American economic policymaking going forward.
Recessions come and go but their effects may linger on and affect economic outcomes in subsequent years.1 As the U.S. economy continues to grapple with the residual effects of the Great Recession, scholarship in American economic policymaking has moved beyond mere post-mortem analyses of what caused the economic downturn [e.g. Stiglitz (2010); Palley (2011)] and whether policy responses to the crisis were adequate or justified [e.g. Blinder and Zandi (2010)] to ex-ante discussions of the mix of policy responses that can contain present and future stresses in the economy [e.g. Dosi, Fagiolo, Napoletano, Roventini, and Treibich (2015)] and improve economic welfare. How monetary and fiscal policies should interact to moderate booms and busts in economic cycles over time has been at the forefront of scholarly discussions.
Regulatory governance is another area of renewed interest among researchers. Over the years, regulation in U.S. policymaking contexts has received both support and skepticism. Supporters of regulation have argued that tighter regulatory schemes are required to correct the welfare costs of inefficiencies in the market system while skeptics have emphasized how regulatory schemes constrain the level of competition in the private sector and limit economic growth processes (Vocino, 2003). More recent research has been motivated by the failure of regulatory systems to effectively counter the range of systemic risks that culminated in the Great Recession. Scholars have explored the subject of regulatory governance from perspectives such as regulatory arbitrage (Kroszner & Strahan, 2011) and regulatory policy uncertainty (Nodari, 2014). Also, following the introduction of a range of regulatory initiatives during and after the Great Recession, questions remain on the extent to which emergent perspectives on regulatory governance in the U.S. serve as standards of best practice and shape regulatory reform approaches in other countries.
Much research exists on the role of institutions in the policy process. Different theories and framework have explained how institutions support incremental policymaking (Lindblom, 1959; Schulman, 1975), provide the venues for punctuated policy changes (Baumgartner & Jones, 1993), and determine the extent to which members of advocacy coalition groups can have access to policymaking venues and shape policymaking (Sabatier and Jenkins-Smith, 1988). Indeed, institutions are central to economic policymaking because they define the rules, norms, and strategies within which actors make routine policy choices and major constitutional decisions that affect policy outcomes (North, 1990; Cram, 2005; Ostrom, 2007). Recent research has built on the theoretical foundation of earlier scholars to investigate further the dynamics of institutional relationships in the policy process. Scholars have probed how policy narratives influence policy outcomes, how the media engages and alters political attention, and how interest groups and lobbyists shape policy decisions.
This essay examines recent scholarship in American economic policymaking. It reviews research on monetary and fiscal policymaking, regulatory governance, and institutional dynamics in the policymaking process. Studies published in the years spanning 2012 and 2015 are the main focus of the essay. References to earlier studies provide background and context to the discussion. I ask the following question: what new insights emerge from the current state of research on American economic policymaking, and how will these affect policymaking, going forward? In the next sections, I examine research on how monetary-fiscal policy interactions affect economic outcomes, review studies on regulatory governance, discuss new insights on institutional dynamics in the policy process, and outline ways in which these new insights could shape American economic policymaking in the years ahead.
Renewed focus on the optimal combination of monetary and fiscal policies that promote economic welfare can be traced to perceived failure of economic policy to prevent the systemic risks that eventually led to the Great Recession. Scholars have noted that monetary and fiscal policies became more discretionary and less predictable in the years leading up to and during the recession. Monetary policymaking deviated from its rule-based path as the Federal Reserve held interest rates unusually low (relative to the policy stance in the previous two decades) in the years preceding the Recession (Taylor, 2014). The Federal Reserve’s deviation from the monetary policy reaction function was in response to deflationary pressures in the economy. However, rather than bolster economic activity, the change in stance spurred severe risk-taking, resulted in a housing sector bust and brought immense losses to financial institutions (Bordo & Landon-Lane, 2013) which depressed economic growth and employment further (Taylor, 2014). In the same vein, fiscal policy during the recession years served to provide a short-term boost to the economy, instead of promoting a sustained recovery consistent with the size of government spending in this period (Cogan, Cwik, Taylor, & Wieland, 2010).
Contemporary research on monetary-fiscal policy interaction has emphasized timing and sequencing as well as market agents’ beliefs and expectations as essential elements that shape interactions between monetary and fiscal policies to influence economic welfare. In regard to timing and sequencing, the literature identifies three potential causes of conflict: first, monetary and fiscal authorities might each react strongly to a negative economic shock and the combined impact of their policies may be excessive, resulting in overheating of the economy; second, both authorities might delay their response to a shock in anticipation of the other authority reacting to the shock and this would deepen the economic contraction; and third, the timing mismatch between monetary austerity and fiscal stimulus might result in high rates of volatility in inflation and output thereby constraining welfare improvement (Libich & Nguyen, 2015). Judging from the contemporary literature, a desirable sequence for monetary-fiscal policy interactions is one that promotes fiscal leadership, wherein fiscal policy is determined before monetary policy in order to achieve both inflation conservatism and fiscal discipline (Adam & Billi, 2014), or a timing sequence that allows fiscal policy to accommodate and support changes in monetary policy over an extended time span (Bianchi & Ilut, 2014).
Market agents’ beliefs and expectations determine whether monetary and fiscal policies can interact in a manner that results in economic welfare improvement. Agents’ expectations tend to be less supportive of economic policy if monetary and fiscal authorities’ interactions generate conflicts and cause sub-optimal macroeconomics outcomes. Loss of credibility among market agents weakens the degree to which policies can be anchored in market expectations and sets off a vicious circle that worsens macroeconomic outcomes (Libich & Nguyen, 2015). Bianchi (2012) and Bianchi and Melosi (2013) tested the role of agents’ beliefs across changing monetary-fiscal policy interaction regimes (active monetary policy combined with passive fiscal policy; active fiscal policy combined with passive monetary policy; and active monetary policy combined with passive fiscal policy) in the United States. He found that agents alter their expectations depending on the credibility of economic policymakers’ responses over time – “decades of lack of fiscal discipline can easily discourage agents about the possibility of a prompt return to a virtuous regime, resulting in dramatic changes in the propagation of the shocks through the economy.” (p.172) Building transparency and accountability into monetary-fiscal interactions is one way policymakers’ can guide market agents to connect short-term policy responses with longer-term economic goals, stabilize agents’ expectations, and enhance credibility of economic policy [Bernanke (2014); Florio and Gobbi (2015)].
Under unconstrained conditions of timing and sequencing, and where policy credibility helps to anchor market expectations, an appropriate mix of monetary and fiscal policy is one that combines counter-cyclical fiscal policy with monetary policy targeting employment. This form of interaction between monetary and fiscal policy is appropriate for stabilizing the economy during times of economic distress, and its effects on stabilization become sharper as the level of income inequality increases (Dosi et al., 2015).
Additionally, central bank independence deepens policy credibility and improves economic outcomes. This traditional view of the role of central bank independence is widely accepted among economists and political scientists (Franzese, 1999) although more recent discussions of the subject (e.g. Hanretty and Koop, 2012; Fernandez-Albertos, 2015) emphasize the distinction between formal and actual independence and note how formal structures that do not translate into actual independence can alter the effectiveness of the monetary-fiscal policy mix.
Overall, the academic literature is in agreement that monetary or fiscal policy alone cannot generate the desired linkages in the economy to maximize welfare. On the monetary policy side, policymakers’ ability to control interest rates is viewed among scholars as largely exaggerated (Thornton, 2014) and their policy responses in times of high unemployment and weak economic recovery have been regarded as markedly passive (Romer & Romer, 2013) with limited effects of welfare. At the fiscal policy front, recent evidence have shown that fiscal policy has lost, somewhat, its capacity to stimulate economic output (Pereira & Lopes, 2014), has only small impacts on consumption and investments (Peren Arin, Koray, & Spagnolo, 2015), and can only boost employment when it combines with monetary authorities to pursue a sustainable bond-financed deficit reduction strategy (Yakita, 2014). Especially during epochs of severe economic disturbance, which might require unconventional monetary policy (Getler and Karadi, 2011; Getler and Kiyotaki, 2015) and non-trivial deviations from rule-based fiscal paths, the need for optimal combinations of monetary and fiscal policy to enhance employment and income conditions of citizens cannot be overemphasized.
Scholars have noted how the failure of regulatory governance systems contributed to the propagation of systemic risks in financial markets, resulting in the Great Recession (Levine, 2012). In the aftermath of the recession, the regulatory governance landscape has witnessed a series of modifications aimed at correcting the ills of the past and averting future systemic stresses. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 increased the power of financial sector regulatory authorities with a view to deepening oversight and minimizing the gaps in regulation. Appropriately, recent studies have refocused on the theme of regulatory governance and explored a variety of topics, including enforcement and compliance, regulatory arbitrage, regulatory policy uncertainty, and global governance.
Enforcement of regulations is a critical element in regulatory governance as it allows for early detection and sanctioning of non-compliant behaviors in the economic system (Etienne, 2015). Recent studies have described how political factors influence enforcement of regulations. Regulatory agencies, whether at the national or subnational government levels, yield to ideological preferences of their political principals and choose which statutes to implement depending on which party is in control of political institutions (Acs, 2015). Also, the greater the degree of independence of a regulatory agency, the more likely it is that appointment of agency leadership will favor individuals that hold the same ideological preferences as the appointing political principals (Ennser-Jedenastik, 2015). Furthermore, politics remains a crucial factor in effective regulatory enforcement within and across different tiers of government (Gerber & Teske, 2000) as exemplified in state and local governments’ resistance towards federal government regulations and unfunded mandates (Vocino, 2003).
Nevertheless, a threshold may exist beyond which sets of regulatory rules and their enforcement may yield suboptimal outcomes. An example is the Dodd Frank Act, which proposed many new rules — numbering more than 200 — in addition to various directives for modifying existing regulations (Coates, 2015). Rule changes proposed in the Act created regulatory policy uncertainty among market agents and, as Nodari (2014) showed, such uncertainty (measured as a news-based index that mimics the reaction of credit spreads to regulatory shocks) can have negative impacts on the real economy.
Compliance, like enforcement, is an important element in regulatory effectiveness. Regulatory governance embraces a large and diverse audience that includes clientele groups, policy experts, and ordinary citizens. Therefore, regulatory effectiveness depends not only on regulatory agencies’ enforcement of rules and procedures but also on audience members’ (or market agents’) behaviors toward agencies – these behaviors effectuate compliance and are a function of audiences’ beliefs about whether agencies can perform tasks effectively (Carpenter, 2010a, 2010b).
A rich literature exists on the features of policy tools that motivate compliance. Schneider and Ingram (1990), for example, discuss how incentives (pay-offs in the form of inducements, charges, or sanctions), capacity building instruments (information that enables individuals or groups to make decisions or undertake activities), and symbolic and hortatory tools (capitalize on people’s beliefs and values or decision heuristics) all help to explain why target populations react the way they do to different (regulatory) policy initiatives. In state and local government bond market contexts, the discourse on compliance has focused on which types of information disclosure requirements — mandatory versus voluntary — are more effective in bolstering market agents’ compliance with regulatory structures (Coffie, 1984; May, 2005). Recent evidence (e.g. Friewald, Jankowitsch, and Subrahmanyamz (2012) seems to favor voluntary disclosure arrangements.
Regulatory agencies are constantly challenged to keep governance apace with current trends as markets become increasingly complex and sophisticated financial instruments proliferate. Amidst these dynamic market conditions, regulatory arbitrage remains a potential danger — institutions might attempt to limit the burden of regulation by engaging in new forms of transactions that are in the “shadows” of regulatory oversight, “where risks may slowly accumulate like dead wood ready to ignite the next wildfire” (Kroszner & Strahan, 2011, p. 243). Strengthening the microstructure of governance systems within stable macroeconomic environments will ensure that regulatory governance remains well-functioning and relevant.
Discussions of how U.S. regulatory structures serve as standards of best practice in other countries are framed around notions of regulatory reform and policy diffusion. Modern regulatory reform began in the U.S. in the 1970s and, ever since, has stretched beyond its initial concentration on transportation and public utility sectors to a wider range of sectors and domains (e.g. financial services, health care, energy, environmental preservation, consumer protection, etc.) and across national boundaries to other developed nations and developing countries (Armstrong et al, 1994). Diffusion of regulatory governance standards across national boundaries has varied greatly in the extent to which new international procedures are adopted and embedded within local structures due to tensions with administrative, institutional, and political conditions in adopting-country systems [Thatcher (2002); Jordana, Levi-Faur, and i Marín (2011); Dubash and Morgan (2012)].
Among developing countries, international financial institutions continue to exert enormous influence in adoption of best practice standards (Dubash & Morgan, 2012). These international institutions often bundle reform recommendations with development assistance facilities. More research is needed to understand the extent to which regulatory reforms championed by international institutions, and conditioned on best practice standards in the U.S. and other developed nations, fit developing country contexts and deliver desired economic outcomes. At any rate, Andrews (2012) has shown that the extent to which best practice fits, and is relevant to, an adopting country’s context determines the extent to which the practice is successful in fixing local regulatory lapses.
Sabatier (2007) described the policy process as the manner in which myriads of actors conceptualize and present problems needing solutions to government, and the ways in which governmental institutions formulate alternatives and select policy solutions that are implemented, evaluated, and revised. Institutional actors (e.g. the president, administrative agencies, legislatures at different tiers of government, and the courts) as well as non-institutional actors (e.g. parties, interest groups, political consultants, think tanks, and the media) play key roles in the policy process (Cahn, 2013). Policy process theories have described different ways in which actors interact within defined institutional spaces to influence public policy outcomes.
Within the institutional analysis and development (IAD) theoretic framework, institutions determine the incentives confronting individual actors and influence their behavior (Ostrom, 2007). Interactions among actors are at three levels: operational tier, where actors interact amidst available incentives to generate outcomes; policy tier, where decision-makers repeatedly make policy decisions amidst constrains prescribed by collective choice rules to influence outcomes; and constitutional tier, where some actors define eligibility rules and make decisions regarding who can participate in policymaking. Since interactions among actors are governed by well-defined rules and norms, the policymaking process generally favors preservation of the system, until some actors set out to change obsolete institutions and rules, with the goal of achieving improved policy outcomes (Petridou, 2014).
The punctuated equilibrium theory (PET) hypothesizes that political processes comprise long periods of stability, but occasionally they produce large scale deviations from past trends (True, Jones & Baumgartner, 2007). The theory “centers on the collective allocation of attention to disparate aspects of the policy process and how shifts in attention can spawn large changes in policymaking” (Jones & Baumgartner, 2012, p. 17). Modest changes occur when non-institutional actors (individuals and interest groups) discuss issues in subsystems (communities of experts) because parallel or simultaneous processing of many issues limits the extent to which a small set of issues can gain political attention at the macro-political level (Congress and the presidency). On the contrary, a major change occurs when an issue gains enough momentum in the subsystem, many actors from other institutional venues become involved in the issue, parallel processing of the issue at the subsystem level breaks down, and the issue gains attention of serial decision-making actors at macro-political institutions (Schlager, 2007). Thus, institutions prescribe the venues at which individuals and interest groups interact with policymakers and define what strategies for gaining the attention of policymakers are acceptable.
In the advocacy coalition framework (ACF), interest groups with shared beliefs interact and form coalitions within the policy subsystem to influence policy (P. A. Sabatier & Jenkins-Smith, 1993). Institutional arrangements circumscribe the extent of openness of the political system within which coalitions operate, determine the degree of consensus needed in the subsystem for policy change, and define the institutional position and resources available to coalitions for influencing policy (Sabatier & Weible, 2007). Policy change occurs when internal competitive forces (e.g. political-interest and self-interest) within the policy subsystem, or external shocks to the system, challenge the policy core beliefs of coalitions and cause the status quo to be unacceptable, making coalitions receptive to change (Petridou, 2014).
Policy process theories and framework, such as the IAD, PET, and ACF discussed above, provide insights on the institutional environment within which U.S. economic policymaking takes place. They highlight the myriads of actors involved in economic policymaking, roles different actors play in policymaking, actors’ strategic location within institutional spaces to gain access to economic policymakers, and the mechanisms by which convergence or divergence of actors’ economic policy preferences occurs within and across different actor-groups. These theories, together with minor modifications to them over time, deepen understanding of contemporary economic policy issues, such as institutional conflict and gridlock between Congress and the presidency in macroeconomic policymaking (Edwards III and Wayne, 2013), judicial influence over congressional economic policymaking at the state government level (Marks, 2012), and the groundswell of interest group activity that culminated in consumer protection legislations across the nation (Sherraden and Grinstein-Weis, 2015).
Understanding of institutional interactions in policymaking has deepened due to new insights on how the media engages and alters political attention, and the ways in which interest groups, lobbyists, and narratives shape policy decisions. The media is often described as an agent of change (Donnelly & Hogan, 2012). New media technologies and information sharing platforms have enhanced the opportunities for political communication and altered how publics engage with government in the policy process (Wasko, 2014). Studies on the role of the media in today’s digital age find that citizens learn extensively from the media about the performance and integrity of political institutions and the information they acquire becomes a critical factor for trust formation and political participation in the policy process (Camaj, 2014). Additionally, the extent to which the media engages the attention of citizens and causes them to participate in the policy process is mediated by citizens’ emotional reactions to major actors — e.g. presidential candidates — in the policy process (Namkoong, Fung, & Scheufele, 2012) and the extent to which they find media information to be relevant to their individual and group interests — a case of selective exposure to politics (Bolsen & Leeper, 2013).
Studies have also compared traditional and non-traditional forms of media engagement of the public. Compared with traditional or off-line mass media forms (e.g. newspapers), internet usage among citizens reduces the degree of trust they have in government and limits the level of their compliance in government policy spheres; however, this negative effect of the internet can be counteracted by government’s engagement with citizens through e-government platforms (Im, Cho, Porumbescu, & Park, 2014). Further, studies show that attention to online news during electoral campaigns predicts interest in the campaign above and beyond that of newspaper and television attention (Lovejoy, Riffe, & Cheng, 2012). In addition, social media, more so than traditional media forms, are a strong force for engaging grassroots support for political parties and their policies. For example, Eom, Puliga, Smailović, Mozetič, and Caldarelli (2015) assessed the number of tweets of a political party as a measure of collective attention to the party and found that tweet volume predicts election outcomes to an extent.
Overall, the manner in which the media engages political attention in the policy process is a good predictor of issue importance and issue knowledge and affects citizens’ public policy preferences (Hyun & Moon, 2014). In U.S. economic policymaking contexts, Rose and Baumgartner (2013) have shown how media framing of the subject of poverty has shifted over the years from discussion of the structural causes of poverty and inequality to portrayal of the poor as taking advantage of the economic system and depiction of social welfare programs as perpetuating a dependency syndrome. They note that government economic policy followed the new shift in media framing of the poor.
Similar to media framing of economic policy issues, interest group activity and lobbying draw attention to issues across multiple economic policy domains and shape policy decisions. Interest groups pursue the interests of their members using tactics such as electioneering, lobbying, and litigating. Lobbyists pursue the agenda of interest groups they represent by locating at different institutional venues within the policy process, and use their resources, strategic location within branches of government, and access to policymakers to influence policy decisions.
Recent scholarship on interest group and lobbyists’ interactions in the policy process have shed more light on interest group mobilization, lobbyists’ agenda development, and resource endowment. Policy regime shifts (such as the dominance of homeland security issues during the years immediately following the September 11, 2001 attacks) cause rapid, but temporary, shifts in the focus of well-organized interest groups, and new interest groups — previously dormant — mobilize soon after the new policy regime becomes entrenched (LaPira, 2014). Additionally, lobbyists representing different interest groups may have overlapping agendas, creating opportunities for information sharing, which can lower search and information costs associated with a policy issue (Scott, 2013). Furthermore, interest groups’ financial resources seem to have minimal impacts on their ability to influence policy, even though resource endowment is linked to specific lobbying strategies that may yield results for the interest group (McKay, 2012).
Emergence of the narrative policy framework (NPF) in the contemporary literature on policy process highlights the increasing emphasis on narratives and their influence on policy. Narratives are stories or scenarios that simplify and clarify policy situations (Roe, 1992). They are transmitted through policy networks and communities. Earlier studies have demonstrated that narratives serve the interests of policy experts who sustain them (Leach and Mearns 1996) and that such stories prescribe policy solutions that may not be applicable in particular situations. Still, policy narratives play an important role in the policy process because they are embedded in institutional structures and rest in cultural and historical antecedents. Shanahan, Jones, McBeth, and Lane (2013) used the NPF to assess an environmental policy issue (proposal to install wind turbines off the coast of Massachusetts). Their work lays the groundwork for future studies seeking to understand the extent to which policy narratives influence economic policy outcomes.
This review of recent scholarship in U.S. economic policymaking focused on three themes — macroeconomic policy interactions, regulatory governance, and institutional dynamics in policymaking. The literature offers new insights on the mix of monetary and fiscal policies that can enhance welfare and shows economic conditions that are necessary for maximal benefits. Contemporary thought on the subject supports policy mixes that combine counter cyclical fiscal policy with monetary policy targeting economic growth and employment creation, within an environment of macroeconomic policy credibility. Going forward, macroeconomic decision-makers will be confronted with the task of deepening transparency and accountability of monetary and fiscal policy processes. Transparency and accountability are essential for anchoring policies further in market expectations, especially during periods of economic recovery when expectations are rebounding.
On the subject of regulatory governance, new insights on arbitrage and policy uncertainty offer a glimpse into the shortcomings of financial market innovation and multiple regulatory changes. Whether there are still lapses within the current regulatory governance framework that permit rent-seeking behavior and arbitrage opportunities remains to be seen. One way to ensure success is for regulatory agencies in various markets and at different levels of government to create new opportunities for coordination and partnerships. This will encourage compliance and help to eliminate the potential for fuzzy jurisdictional areas that spark arbitrage behaviors. Too, growing concern about the many changes in the U.S. regulatory governance system in recent times has led to calls for the use of cost benefit analytic tools in determining whether proposed changes to the system are justified prior to their implementation (Coates, 2015). On this issue, though, there is still no consensus among scholars, especially due to the non-quantifiable nature of some regulatory governance outcomes.
Recent scholarly exposition on the foundational theories of the policy process and institutional dynamics inherent in the process shed more light on the influence of different actors in policymaking. In particular, the expanding role of the media in engaging public attention portends remarkable innovations in the way economic policy decisions evolve among issue publics, going forward. The effect of these changes in such economic policymaking arenas as defense, energy, and climate change are relevant subjects for further research.
Overall, recent scholarship in American economic policymaking present new insights but raise more questions for future research: How should an appropriate combination of monetary and fiscal policies evolve along different phases of the business cycle over the long-term to ensure maximal welfare outcomes across generations? What roles do stability or transience of institutions play in regulatory effectiveness and long-term macroeconomic success? How is the changing face of the media reshaping the character of citizens’ interactions with economic policymakers within and across institutional venues, and to what extent are these new forms of engagement relevant in macroeconomic policy choices? As the U.S. continues to recover from the impacts of the Great Recession, an economic policymaking agenda that draws lessons from the lapses of past regimes to inform long-term strategies will deliver the greatest good for present and future generations.
Komla D. Dzigbede is a Carolyn M. Young doctoral fellow in public policy at the Georgia State University. Previously, he worked as economist in the research and financial stability departments of the Central Bank of Ghana. His research interests span public finance, state and local government financial management, and international development.
1 The National Bureau of Economic Research (NBER) describes a recession as “a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” (NBER, 2010, p.1) The Great Recession, according to the NBER, lasted 18 months, beginning in December 2007 and ending in June 2009. It is the longest recession since World War II.