Government Contracts and Money Velocity - an adjunct to fiscal policy

Fiscal Policy is used by governments as a way of expanding or contracting an economy. Such a policy occurs during the business cycle, whereby a fiscal expansion is enacted when the economy is slowing, and a fiscal contraction is enacted when the economy is in danger of overheating. Traditionally, Fiscal Policy requires legislation to be passed to increase or decrease spending, or to increase or decrease tax rates. Fiscal Policy is problematic in that it becomes a political issue, rather than an economic one. In order for fiscal policy to enacted quickly and properly, political influence must be somehow reduced, and the effects of the policy need to be broadened rather than aimed at a narrow area of the economy.

One solution to this is to ensure that government contracts - the money that governments pay the private sector for providing various goods and services - are given variable payment dates. Usually, when one business purchases goods and/or services from another business, payment for these goods and services is often delayed for a time. One example of this delay would be an invoice that is payable 30 days from the end of the month of the invoice. In this case, an invoice dated 15th May would be due on 30th June. Such invoicing arrangements are common in the private sector. One advantage that this system brings the buyer is the chance to build up liquidity - by delaying payment for a time, the company has an increased cash flow. This invoicing system, therefore, affects Money Velocity - the speed at which money travels through an economy. Increased money velocity is linked with economic expansion and inflation, while reduced money velocity is linked with economic contraction and deflation.

Since governments in Western countries are the largest economic and business entities in their respective economies, the way in which a government pays its bills to the private sector can have a huge impact upon an economy's money velocity.

The process of paying back money owed to the private sector can thus be used as a form of Fiscal Policy - with money being paid back to private suppliers sooner or later depending upon the state of the economy. Once legislation approving this policy is passed, all government contracts from then on would be subject to variable payment dates depending upon macroeconomic need. Payment dates for invoices would be moved from the original date - paid sooner for expansionary policy; paid later for contractionary policy.

As an example, let us assume that a government department agrees on a contract with a private business for the supply of stationary. As this government department buys from this business, the standard invoice (as an example) is 30 days from the end of month of the invoice.  Now let us assume that the economy needs expansionary policy. As a result of this, the invoice due date changes to 15 days from the end of month of the invoice. Thus the stationary company ends up with its money sooner, thus increasing the velocity of money. Now let us assume that, instead, the economy needs contractionary policy. As a result of this the invoice due date changes to 45 days from the end of month of the invoice.

There are a number of advantages to this model:

  1. This policy would fall under the scope of "automatic stabilisers" in the sense that any changes needed to the economy can be enacted straight away.
  2. There would be less need for legislative debate amongst politicians about if and how changes to government spending should be made (in the case of debating Keynesian stimuli)
  3. The effects of the policy will be broad - affecting the areas of the economy which deal directly with government contracts.
  4. The policy will be budget neutral - it would neither increase or decrease a budget deficit in real terms over the course of the business cycle.
  5. It does not replace current Fiscal Policy, but rather adds to it and may even reduce the need for such policy over the longer term.
  6. The government department responsible for enacting this policy need not be secretive but can operate faithfully in full view of the public. There is no reason for hiding information for the sake of national security - this needs to be the case given the chance that those who benefit from government contracts could attempt to corrupt the decision making process.
Important points to consider:
  1. Size of government: will the effect on the economy be bigger if governments are bigger (as a proportion of GDP)? Will the effect be smaller if the government is smaller?
  2. Should this system include welfare payments and payments to government employees? (I think not, but it is a point to discuss)
  3. How much should the government department reponsible for this policy be allowed to be influenced by central bank information? Should the Central Bank be responsible for this policy, and enact it along with Monetary Policy?
  4. Would such a policy function well in a single-currency area like the Eurozone?
  5. Would such a policy function well for non-national governments, such as state governments and municipalities?
  6. What should be the natural limits of this policy? Could super-expansionary policy involve paying for goods and services before they are supplied or even ordered? Could super-contractionary policies involve debt default?
  7. How would such a policy affect governments who purchase goods and services from foreign suppliers?
  8. Should some private sector suppliers be exempt from this policy? (I think not, but it is debatable)

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