Krugman explains why a broken window is a fiscal stimulus
27 Sep 2014 Leave a comment
HT: Robert P. Murphy
Most fiscal stimulus arguments ignore basic facts
02 Aug 2014 Leave a comment
in budget deficits, fiscal policy, macroeconomics Tags: crowding out, fiscal deficits, John Cochrane, Ricardian equivalence
The
Keynesian analysis implicitly assumes that a fiscal deficit does not have any effects on other spending
01 Aug 2014 1 Comment
in budget deficits, fiscal policy, macroeconomics, Milton Friedman, monetarism Tags: budget deficits, fiscal policy, fiscal stimulus, Milton Friedman
The
Eugene Fama and the simulative effects of fiscal policy
31 Jul 2014 6 Comments
in budget deficits, fiscal policy, great depression, great recession, macroeconomics Tags: crowding out, Eugene Fama, fiscal policy, Treasury view of fiscal policy
Eugene Fama argues that government bailouts and stimulus plans seem attractive when there are idle resources – when there is unemployment such as in a recession or depression including in the 1930s.
Fama counters that:
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another.
Fama noted that there was just one valid negative comment in response to this argument that appears to be valid which was made by Brad DeLong.
Fama thinks Delong’s point about involuntary inventory accumulation is consistent with Fama’s initial arguments about the need for the stimulus to work through moving resources to higher value uses.
For me, the notion that a fiscal stimulus is a negative productivity shock is a good starting point for analysis. The method of financing the stimulus is important too.
Economic agents know that a temporary expenditure program has no lasting effect on employment but has lasting effect on disposable income and taxes. Indeed, massive public interventions to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a depression.
In Australia, there was a massive fiscal contraction from late 1930 onwards called the Premiers’ Plan. In 1931, unemployment rates was 25% or more.
- The Premiers’ Plan required the federal and state governments to cut spending by 20%, including cuts to wages and pensions and was to be accompanied by tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans.
- The Premiers’ Plan was complementary to the Arbitration Court’s 10 per cent nominal wage cut in January 1931 and the devaluation of the Australian pound. Most countries had abandoned the gold standard by 1931 and 1932 and devalued by about 10% including the UK. These competitive devaluations were called currency wars. Most countries below started to recovery before they left the gold standard, a year or two before they left the cross of gold.
Maclaren (1936) dated the Australian economic recovery from the last months of 1932. It was to take another three years before unemployment rates fell below 10 per cent — the rate it had been during most of the 1920s.
The June 1931 Premiers’ Plan of fiscal consolidation had time by late 1932 to become credible and take hold given the usual leads and lag on fiscal policy. Unemployment data for the time show a rapid fall in the high twenties unemployment rate in 1932 to be below 10 per cent by 1937.
“Inflation is always and everywhere a monetary phenomenon”
31 Jul 2014 Leave a comment
in budget deficits, fiscal policy, macroeconomics, monetarism, monetary economics Tags: Joan Robinson
Joan Robinson thought German hyperinflation was not caused by monetary policy!!
Almost, but not quite.
Back in the days when dinosaurs roamed the earth, and Cambridge economists kept guard at the Temple of Keynes, Milton Friedman’s focus on inflation as a monetary phenomenon was a revelation—and an excellent one. Next to Joan Robinson’s surreal claims that printing money was not responsible for the German hyperinflation, Friedman’s version of monetary economics provided a very healthy dose of sanity. And as central banks across the world learned from the mistakes of the 70s and brought inflation under control, it became clear that the monetary authority indeed had the power to contain the price level via control of the money supply.
But it’s important to know what this account leaves out: how, exactly, do prices adjust? And over what length of time does this happen?
The modern view, backed up by impressive (though not entirely conclusive) empirical evidence, is that most prices are…
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Does fiscal policy cause inflation?
11 Jul 2014 Leave a comment
in budget deficits, fiscal policy, macroeconomics, Milton Friedman, monetary economics Tags: budget deficits, fiscal policy, inflation
Does a fiscal stimulus stimulate?
26 Jun 2014 Leave a comment
in applied price theory, budget deficits, business cycles, fiscal policy, macroeconomics Tags: Eugene Fama
The voter as a fiscal conservative
16 Jun 2014 Leave a comment
in budget deficits, macroeconomics Tags: Ricardian theory of budget deficits, Robert Barro
Now that every election policy must be fully costed, and every major party promises a return to surplus in a few years, the Ricardian theory of budget deficits is now an optimistic view of the power of fiscal policy.
By running a budget deficit, it shifts from collecting taxes today to collecting them tomorrow and fund the intervening shortfall was selling government bonds to the private sector. A finance minister may choose to lower taxes today (thereby increasing the deficit), but without any planned changes in the government’s expenditure program, such a policy must imply higher taxes at some point in the future.
The Ricardian theory of budget deficits is people are smart enough to recognise that today’s fiscal deficits mean tomorrow’s taxes must increase to to repay the debt so taxpayers cut back consumption dollar for dollar to save for those future taxes.
If you know your taxes will go up in the future, the right thing to do is save to pay those higher taxes. A fiscal stimulus is then completely offset by the reduction in private consumption. The stimulus has no effect on spending, prices, production, or interest rates because households know that deficit spending means future taxes: to smooth consumption, they save more now.
To make things worse, the lower taxes today and the higher taxes tomorrow encourage intertemporal substitution of labour. People will work more now because taxes are low but work less in the future when taxes are high. Investors also take into account that taxes on their investment income will be higher in the future so they will invest less now.
Notice below the mirror trends of net private and government savings as a per cent of U.S. GDP. Financing U.S. government consumption through deficits or through taxation is equivalent: households know net present value of taxation will rise and save to offset that.
HT: correctionspageone.blogspot
If you think a fiscal stimulus works by fooling people into ignoring the future tax hikes or spending cuts, then loudly announcing in an election campaign those tax hikes and spending cuts in a few year’s time that will pay for the current fiscal stimulus must undermine that stimulus even more!
When Robert Barro wrote in the 1970s and 1980s, he pointed out that there is no reason to assume that forecasting errors about future taxes are always biased in the direction of under-estimating the future taxes. People can over-estimate the future taxes. Individual uncertainty about their future tax liabilities does not normally induce them to save less, it induces them to save more.
The fact that much political debate surrounds government budget deficits clearly suggests that the voters understand the government budget constraint and that high budget deficits today signal higher taxes in the future and they change their behaviour accordingly.
Robert Barro likes to refer to Israel as a natural experiment in the Ricardian budget deficit theory. In 1983, the national saving rate of 13% of GDP corresponded to a private saving rate of 17% and a public saving rate of -4%. In 1984, the dramatic rise in the budget deficit reduced the public saving rate to -11%. Private saving rate rose to 26%, so that the national saving rate changed little. Then a stabilisation program in 1985 eliminated the budget deficit, so that the public saving rate rose to 0% in 1985-86 and -2% in 1987. The private saving rate declined dramatically to 19% in 1985 and 14% in 1986-87. The national saving rate remained relatively stable, going from 15% in 1984 to 18% in 1985, 14% in 1986, and 12% in 1987.
The best evidence that people do take future taxes into account is the method in which old age pensions are financed in different countries. An expansion of social security pensions for the retired is analogous to a deficit-financed tax cut. People respond to more social security by shifting private intergenerational transfers, rather than by consuming more.
In the US, the growth of social security strongly diminished the tendency of children to support their aged parents because they are paying taxes now and in the future to support them. In countries were weak social security, children spend more of their money looking after their parents.
51% of nonretirees doubt they will receive Social Security… on.gallup.com/1NcwzEa #GallupDaily http://t.co/ZhKnHYtr1X—
(@GallupNews) August 13, 2015
It is certainly the case that most younger people think they have to provide for their own retirement and that government will not tax enough to support them in 20 to 30 years time.
People have relatively sophisticated views of both long-run government spending and taxing in an ageing society and that deficits must be paid for. The voter is a fiscal conservative.
Utopia, you are standing in it! 
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