I think that this is a question that is fairly easy to answer in theory but in practice is very difficult because it depends on whether politicians and policymakers can be bound by pre-existing law. My belief is that fiscal policy should seek to maintain a target debt-to-GDP ratio over time--I have no quarrel with the 60% figure used in Europe (but not observed). However, excluded from this should be a government cash reserve, which is accumulated in the expansion phase and spent during the contraction phase of the cycle. Easy and simple. No boosting spending in expansion or making unwelcome cuts in recession. In practice, however, how are politicians prevented from raiding a pot of cash for their own (non-cyclical) purpose? Another problem is how are decisions made on what this cash is invested in. I agree that the current emphasis on austerity to hit a deficit target is unwise (but so is making no reform at all in many countries).

First of all i find building reserves by governments counterproductive, as reserves cannot be kept without investing them, and that can create the mother of all bubbles. Governments collecting taxes and piling up the money is an even worst idea, having in mind money can be "printed" in unlimited quantities, and keeping in mind the fiscal burden is focused on fair businesses.

My theory is that we should build foam instead of bubbles. Smaller bubbles bursts have manageable consequences. So markets should be atomized, but that can only be done globally, as local small businesses will always have a hard time keeping up with global huge corporations. We need hundreds of stock-exchanges, millions of banks and investment funds, connected but divided in a globalized network of non-critical nodes. We need a whole new way to identify and direct response towards systemic risks. Market makers? To dangerous to exist...

I think your concerns equate to my fears in practice. Textbooks are full of wise and well meaning policy makers. The world seems rather devoid of them!

Usually science writers have little power, and small political influence. Big corporation have big power and huge political influence.

I am not an economist but i think the problem is Capitalism is no longer practiced the way it was before.What happened after Lehman Brothers crashed was Socialism to the financial industry and Capitalism to everyone else.

If accumulating a "War Chest" and investing it during boom years risks creating bubbles, then let's forget about it.

But there is still a need for an automatic buffer system.

I could imagine the inverse of a War Chest system: a debt buffer system whereby a central bank, with its "unlimited firepower", would lend the state "as much money as it takes", for "as long as it takes", in order for a state to meet its functional expense requirements, PROVIDED an on-going rationalisation of public finances and economic policies takes place, and that debt becomes redeemable once there is sustainable growth in the economy. In other words, no limited cash buffer, just a flexible debt buffer.

Wouldn't that help the state become a-cyclical or even anti-cyclical?

Of course such a system would be unpopular in boom times, but politicians can always put the blame on their predecessors, and benefit from the boom time effects anyway.

That's the reason QE and LTRO were invented, and why the currency issuer is not under government control.

It is unclear if the states can actually prevent economic cycles. I see little if any way to prevent a cyclical paradigm change within the paradigm unless some visionary leadership is present at the right time in the place and context.

OK, individual states cannot prevent world-wide economic cycles, but if they can neutralise their effects, and not contribute to spiralling downturns, this is still a desirable outcome!

There is an asymmetry between deficit reductions and deficit increases that biases most economies towards overextending spending and running into financial problems. The case of states in the U.S. is an interesting one because they almost all operate under a balanced budget requirement. When revenues are surprisingly good, there tends to be a surge in spending (no rainy day fund). When revenues fall back with the cycle, then states run into difficulties and look for ways to hide spending or seek revenue increases to support the new higher level of spending. So, states have accumulated (partially) unfunded liabilities related to public sector workers (don't take a pay increase now but we can sweeten retirements when I am no longer in office to pay for it). Failing that, the states have to come up with sharp, pro-cyclical cuts as we have begun to see in the U.S.

Economic cycles are normal, even so the deepening of the recession and shortening of expansion periods on this days are result of the new accumulation frame where capitalism moves towards the financial area. So in Hyman Minsky`s theory framework we know the bankers during they "normal" activities make the financial bubbles possible; although today's most legal restrains have been deleted giving perverse incentives to the financial sector, where flows of investment goes from productive sector into the financial sector, searching for bigger and faster profits. Changing the main variables that drive the economic cycles, from productive investment on a economic growth cycle into a financial bubble bursting cycle. In conclusion the fiscal policy should remain anti-cyclical, legal frame should give restrains to the financial investment and last but not least the government spending ought to be done in productive areas and / or job generation; in order to give efficiency to fiscal and monetary policy.

Maybe counter-cyclical rather than anti-cyclical would be a better term.

Generally speaking, any economic agent need stability. Cycles may be the norm, but that does not make it right. The norm must and can be changed over time. Especially in the context of Europe.

Any member state of the EU is much more dependant on the rest of Europe than on the rest of the world. So once a concensus is reached (!) on how much targeted QE is desirable for each state, counter-cyclical QE should at least help stabilise economies, and make eccentric economies converge towards the average. That is, if QE is carried out better than it has been so far.

I appear to be in the mood to channel Milton Friedman today (see my post on inflation). However, the I am of the view that policymakers have forgotten many of the lessons of the 1970s and are massively overconfident in the ability to fine-tune the economic cycle (or in this case reboot the economy from the prolonged recession and slow recovery). I think the idea that QE or rmonetary policy in general can manage the economy falls into this trap. Even if they could, the Enrique is probably right about the Minsky effect. The lack of volatility induces the creation of too much risk and this eventually undermines the expansion (the story of the last decade). I am no biologist but it seems to me that the evidence is growing that variations in environment (exposure to dirt, microbes etc. at an early age) strengthens immunity, reduces the risk of certain illnesses etc. There may be something to this Anti-Fragile view of economies (hat tip to Taleb).

I agree, counter- cycle is a better term, because the cycles can`t be eliminated although their effects can be prevented. So at this matter I`d like to point out about the effect of balance sheet recessions, in words of Richard Koo, the last two or three decades we have witnessed a new development on the financial recessions, today monetary policy has proved inefficiency, example Japan`s lost decade and US recession, where household like bankers or non financial corporations were broke, so there is plenty of fiscal policy space. Because the private investment won´t get crowd out and extra money won´t be inflationary , under an environment of households saving and corporations minimizing debt, spend and investment get set into their minimum, on private sector hand, giving the responsibility, to fill those spaces, to the Government. Concluding, fiscal policy is necessary throughout the fight of recessions for developed open economies with wide and deep financial markets.

The one factor that takes away from potential flexibility of iscal policy is credibility of long-term budget reform. I disagree with DeLong and Krugman that the current low level of yields show that there is plenty of room for fiscal stimulus. Yields are being repressed by QE and there is no real price discovery taking place. Meanwhile, the long-term credibility of the budget is in doubt because of the failure to put mandatory programs (particularly social security and Medicare) on a long-term sustainable path in the face of an aging population. The combination of fiscal stimulus and monetary financing through QE has the potential to be inflationary and destabilizing. If debt to GDP, which has risen from 40% to over 70% rises to say 80% or higher as a result of 'stimulus' and rates then renormalize, the U.S. will have to run primary fiscal surpluses because interest on debt service would consume over 4% of GDP, while the fiscal deficit would have to be around 3% of GDP to stabilize the debt to GDP ratio.

Long term budget reform with an eye towards sustainability of so-called entitlement programs combined with a flexible balanced budget amendment [see TAX NOTES paper].