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Staff Summary of Testimony to the PCSCB: Gramlich, Federal Reserve System

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Edward M. Gramlich, Member, Board of Governors, Federal Reserve System
(appearance on March 6, 1998)

Testimony: Mr. Gramlich stated that there is no need for a capital budget for analytical purposes. From an aggregate demand point of view, it does not matter whether the Federal government purchases consumption goods or capital because production and employment will be generated in roughly the same amounts. It also will not have a significant effect on the amount of Federal borrowing. While long term economic progress in the U.S. depends on our level of investment in capital, there is no need for additional information regarding the classification of Federal spending because the national income accounts already identify the share of our output devoted to investment goods.

The key issue is whether the unified budget should be separated into two or more budgets - an operating budget, a budget for trust fund financed entitlements, and a capital budget - to provide a better basis for political decision-making. With regard to a capital budget, Mr. Gramlich raised a number of issues to be considered. First, would there be spending caps on a capital budget? If there are different limits on the amount of capital spending as opposed to other types of spending, a host of political and definitional problems will likely arise. It will be difficult to referee the capital definition process.

Outside of political considerations, it will also be difficult to define capital. Capital spending should result in tangible physical equipment, such as military and domestic investment in long-lived durable goods. Grants to State and local governments would not qualify because such spending does not directly result in capital equipment purchases because the recipient government can choose to not use the funds for capital equipment. Human investment programs would also not qualify because it is not clear that such investments really increase a person's market output.

A capital budget is supposed to reflect underlying asset values. Annually, there must be a deduction from the value as it depreciates. It will be very difficult to calculate realistic rates of depreciation that Federal managers and Congress can agree upon.

He doubted that the benefits of defining capital spending, and devising new budget procedures, would be worth the trouble.

Question from the Commissioners:

Q.    If States and localities have managed to successfully implement capital budgeting, should not the Federal government do the same?

A.    There are numerous difference between States and municipalities and the Federal government that make capital budgeting less attractive at the Federal level. For example, generally at the State or local level there is a prohibition from borrowing to finance the operating budget.  The kinds of issues that arise at the State and local level simply don't arise at the Federal level.

President's Commission to Study Capital Budgeting

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