« What instead? | Main | Assorted links »
What instead? 2
Matt Ygelsias asks what’s the stimulus-skeptics’ alternative prescription? Tyler offers his recommendations below. I'm somewhat less of a skeptic about fiscal policy than Tyler - there is a good case for moving up useful infrastructure spending (both public and private) today - but I agree with Tyler that it is too early to think that monetary policy is ineffective. M1 is rising sharply, M2 is up. Monetary policy works with lags. As to what to do instead I have offered a number of possibilities including:
1) Investment Tax Credit Unlike traditional fiscal policy an investment tax credit cannot be fully crowded out and it works best when it is expected to be temporary. Cuts in income taxes stimulate the least when they are expected to be temporary. But in contrast, an investment tax credit stimulates the most when it is expected to be temporary because a temporary credit must be used now or lost while a permanent credit gives you the option to wait.
2) A supply side stimulus: The IRS knows how much income that each taxpayer reported last year. So let's cut everyone's marginal tax rate based on last year's income. In other words, suppose that last year Joe earned $66,520 which puts him in a 25% tax bracket. Joe's tax schedule this year will be exactly the same as last year except for every dollar earned above $66,520 the tax rate drops to 15%. We do this for all taxpayers so that each taxpayer has their own schedule and for each taxpayer there is a decreasing marginal tax rate.Note that this plan increases the incentive to work and it doesn't increase the deficit. In fact, the Tabarrok plan increases tax revenues! The key is a marginal tax cut with a different margin for every taxpayer based upon last year's return.
3). A cut in the payroll tax ala Singapore. If employment is down reduce the cost of employing labor. This policy has lot to recommend it because unlike a fiscal stimulus it lets the reallocation process work towards its long run equilibrium. A construction stimulus, for example, pushes people into construction (or keeps them there) when perhaps labor could ultimately be more productive in other sectors of the economy. The payroll tax cut enhances this reallocation effort it doesn't impede it.
4) Don't Panic. This is the policy that has cured most recessions. The do anything and do it now mindset feeds panic. I do think this recession will be longer than average and quite deep, it is a concern that it is worldwide. But recessions are normal and we have unemployment insurance and other assistance programs to help people through tough times. The economy will recover and its very possible to make things worse by trying to make things better.
Posted by Alex Tabarrok on January 24, 2009 at 11:06 AM in Economics | Permalink
Comments
Economists have long known the conditions when government can increase real wealth---providing public goods, mitigating negative externalities, etc. Macro models where generic government spending, or tax cuts, do the same don't obviate all that and are, in some respects, little more than formalized wishful thinking regarding government's ability to spin flax into gold. At a fundamental level, such models deny that market participants, given the costly information and uncertainties they face, are putting resources to their most profitable uses. (How else is it even possible for fiscal stimulus to expand real output?) Yet even a brief exposure to the realities of government decison processes makes it nearly impossible to believe that politicians and government bureaucrats have some kind of informational advantage over market participants. The likely outcome of all the stimulus spending currently being proposed will be increased government borrowing, monetized by the Fed, and all the attendant inflationary cost that entails. So to Yglesias' question, Is the anti-stimulus idea to do nothing and hope for the best? my answer is yes so far as "stimulative" fiscal policy is concerned. Let government concentrate on not adding to economic uncertainty.
Posted by: Bill at Jan 24, 2009 11:42:17 AM
The lag on monetary policy is generally considered to be plus/minus one year (12 months). But the Fed started easing aggressively a little over a year ago.
So we should already be in the period when monetary policy works the strongest.
If monetary policy was working we should already be starting to see the impact in
retail sales and other measures of consumer spending and in the housing sector as well. In addition because of the drop in oil prices we are stating to see much lower inflation and rising real incomes. These should be showing up in improving consumer confidence and better consumer spending. Consumer confidence may actually be trying to bottom, but aside from that there are few signs that the past years aggressive easing by the Fed is working.
What do you need to see to conclude that monetary policy is or is not working?
Posted by: spencer at Jan 24, 2009 11:46:14 AM
"Note that this plan ... doesn't increase the deficit. In fact, the Tabarrok plan increases tax revenues!"
I like most of your suggestions but you're overselling this idea. The plan will almost surely reduce revenues (which is okay, btw). If Apple makes a big profit and gives pay raises or capital gains to some people, then those people will pay less taxes under the Tabarrok plan than they would have otherwise. You seem to assume that employees, contractors and shareholders can fully control how much they get paid. If only that were true. Of course, then we wouldn't be in the situation in the first place.
Posted by: a student of economics at Jan 24, 2009 11:58:27 AM
Alex, I think these are generally good suggestions. Nevertheless, I think suggestion #2 is unlikely to help. If business is slow for Joe (hey, it is a recession, right?), he will likely have to work much harder this year to get to where he was last year. If his income is lower in the first place, you aren't affecting his marginal tax rate. In other words, this is a good stimulus proposal if you're in an expansion, but not if you're in a recession.
You could make it work better by making the 15% bracket kick in at, say, 80% of last year's income.
Posted by: Eli at Jan 24, 2009 12:31:53 PM
Not panicking is an extremely wise plan if you are a tenured academic Phd in academia where
there never seems to be any busy cycle. If you work(ed) for Circuit City or Harley-Davidson
it might be more difficult.
Posted by: SickofHypocrites at Jan 24, 2009 12:34:57 PM
business cycle not "busy cycle"
Posted by: SickofHypocrites at Jan 24, 2009 12:36:25 PM
The feeling of the abyss!
OK, so we have Hank giving his pals $450 billion, Obama's people are going to get a trillion.
Since none of that addresses our problems, I have an idea. Take the trillion and subsidize six month and one year savings interest rates for the poorest. Thus, whatever changes we make, they have help in minimizing their proportionally larger volatility.
Posted by: MattYoung at Jan 24, 2009 12:42:53 PM
The Federal Funds rate is still not at zero. It is at a range of 0 - .25 percent. It only reached that low in December 2008.
Quantitative easing has hardly been tried even yet.
The Federal Reserve only starting lowering interest rates a year ago. Why isn't it working?
Well, with hindsight, we now know that the drops that had been done a year ago, were not adequate to maintain spending now. This does not show that the drops in rates that occured last spring or summer are inaqequate to cause an increase in Spending this summer.
Or that hypothetical quantitative easing we might do now won't be sufficient to cause enough spending by next year, so that "fiscal stimulous" through government spending projects will not be necessary.
If those spending projects are going to occur, and if it is plausible that they will raise aggregate demand, then the Fed should do less quantitiative easing now to avoid inflation.
Monetary policy isn't working like it used to doesn't mean that monetary policy is ineffective. And, as said before, just because lower targets for short term interest rates are impossible doesn't mean that other sorts of monetary policy are ineffective.
Posted by: Bill Woolsey at Jan 24, 2009 1:12:41 PM
5. STOP PAYTING INTEREST ON RESERVE BALANCES
Posted by: Bill Woolsey at Jan 24, 2009 1:15:23 PM
Shorter (1): tax cut for the rich. Shorter (2): tax cut for the rich. Or maybe not "the rich" but for people who are least affected by the recession. (1) helps people who were smart or lucky enough make money in a bear market and (2) helps people whose job was unaffected by the recession (they made more this year than last year).
The payroll tax cut is a fine idea though. Or perhaps more targeted: a business tax credit for new hires. Hiring someone new is a risk and a tax credit could offset that risk and increase liquidity in the job market. (Also increase temporary hires, but that's not a bad thing.)
Posted by: Brian Slesinsky at Jan 24, 2009 1:18:48 PM
On the 'don't panic' part of your plan: When exactly would be the appropriate time to panic? There is a 12 month recession that is just getting worse, monetary policy has no traction, negative feedback loops show no signs of diminishing. The point of a stimulus seems to be part of a general strategy to unwind those loops. Should the US just wait a couple more years to see if the quantitative easing will do the job, and only then, with GDP is down 15%, and the structural deficit prohibitively large, get creative with fiscal policy?
the general skeptical position of "we don't know if it will work, so lets do nothing" seems like a non-sequitur. If it doesn't 'work' there will be an extra trillion on the national debt, a few better schools and roads, and some tax credits sitting in savings accounts across the country. I really don't see what there is to be so terrified of.
Posted by: obey at Jan 24, 2009 1:36:55 PM
Small Business to get Short Shrift from the Obama administration
http://pajamasmedia.com/blog/small-business-to-get-short-shrift-from-obama-administration/
Small business is the best hope for pulling the US economy out of the recession but the Obama administration is putting serious obstacles in its way.
(Sorry, didn't know where else to submit the link.)
Posted by: Tristan at Jan 24, 2009 1:37:03 PM
Here's a puzzle:
Why are state and local governments slashing spending, canceling projects that are underway, raising taxes and fees and generally doing the exact opposite of stimulating the economy, while the Federal gov't is scrounging around looking for new "shovel-ready" projects to identify, plan, and launch?
Before starting new project, which may or may not pass traditional cost-benefit tests, shouldn't we make sure that projects that were already approved aren't canceled? It's crazy to freeze construction on a court house that's already 90% complete to save money.
The simplest way to do fix both problems is to give large federal block grants to every state that they can a) spend project that they have under way or wanted to do anyway or b) simply rebate to their citizens if they don't see good projects to spend the money on.
Someone needs to put the Federal gov't in touch with state and local gov'ts.
Posted by: a student of economics at Jan 24, 2009 2:03:46 PM
One thing no one is talking about are the automatic stabilizers, like food stamps and unemployment compensation. These are pro-cyclical fiscal stimulus and already in place. How well are they working, out of curiosity? Has anyone ever measured the multiplier attached with these? My thought would be that people who are recipients of food stamps and unemployment comp have extremely high marginal propensities to consume, thus implying the multiplier effects on that margin should be some of the largest.
Posted by: jason voorhees at Jan 24, 2009 2:29:22 PM
Obey,
The correct time to panic will be announced on this blog - this way we can all panic at the same time.
Posted by: Alex Tabarrok at Jan 24, 2009 2:58:30 PM
What most of us seem to be coming down to, by various routes with Robert Lucas once more in the lead, is that the only thing that can work quickly is very large scale injection of governemnt money into the private sector (and into the autonomous public sector - chiefly states and municipalities). This money may be channelled through 'spending', tax cuts or lending. Most of it will be used to rebuild reserves and balance sheets in the first instance, but that will reduce needs to cut spending, and therefore tend to maintain demand. Further, it will tend to prevent a general fall in prices - which would worsen balance sheets - and to maintain 'normal' inflation which slowly erodes debt burdens. We should get on with what may be sensible extra public spending which can be done quickly, but there is not much of it.
There is a real risk that, given the massive need to rebuild balance sheets and to reduce the payments deficit, that domestic demand will remain insufficient for years. This is therefore a good time for the USA to be launching renewal and up-grading of public infrastructure which has a good chance of paying for itself by improving future productivity of the economy. These programmes will deliver very little demand this year and next, but can (and given Obama's program, will) matter thereafter for maintaining demand.
Rebuilding of balance sheets may well over-shoot, releasing an inflationary wave of demand. As Lucas has told us, it will be important to be able to take money out of the economy fast when that looks like happening. 'Quantitative easing' is quick to reverse, and tax cuts can be if designed that way. Infrastructure projects can't, and generally should not, be quickly cut back.
The biggest potential snag is that the USA will remain a major international borrower for some time to come. A Federal defict in the trillions could easily damage the sense that there is no safer place in the world to park money than in the USA. A requirement of massive monetary or fiscal stimulus is that the USA carries the rest of the world along in the belief that such temporary deficits make sense.
Posted by: David Heigham at Jan 24, 2009 3:10:06 PM
There is no doubt that fica is regressive and a cut in it would probably be more
stimulative than cutting many other taxes. However, we have all these hysterics
declaring that social security is in crisis, with them now having gotten to Obama
(probably in the person of Larry Summers) after he had reasonably put off such views
during the campaign and is now all for "reforms" entitlement spending. Generally when
we have had that done to social security, the outcome has been a cut in benefits and
an increase in fica, or a proposal to engage in some privatization, which simply
makes the fiscal situation of the program in worse shape.
So, how does a cut in fica sit with all this sort of nonsense?
Posted by: Barkley Rosser at Jan 24, 2009 3:46:36 PM
Point 2 is absurd: we 80-hours-a-week workers are already working at capacity (beats being fired.) We (Wall St, etc) expect less comp in 2009 than 2008: the tax break is worth 0 to the hard workers, but maybe is worth something to those who got lucky for some reason (switched into foreclosures from waiting tables.)
The main payoff from that plan would be to move oodles of deferred comp into real income. Yes, you get a short-term revenuse tax boost, but at a big long-term cost.
Is this really what you want?
Posted by: gorobei at Jan 24, 2009 3:54:45 PM
"Obey,
The correct time to panic will be announced on this blog - this way we can all panic at the same time."
If by panic you mean SAKE BOMBS!!!!!!!!! Why worry when you can drink?
Posted by: Robert Olson at Jan 24, 2009 3:58:43 PM
Not panicking is an extremely wise plan if you are a tenured academic Phd in academia where there never seems to be any busy cycle. If you work(ed) for Circuit City or Harley-Davidson it might be more difficult.
Yes, because panicking in any situation is so helpful.
Posted by: at Jan 24, 2009 4:00:40 PM
Our problem is much more severe than a temporary downturn. We now know that our wealth of 2007 was phony, based on a mountain of leverage teetering on the unquestioned assumption that some drywallers in Palmdale would actually pay off their half million dollar mortgages.
So, the real question is not: how do we stimulate consumption once again to unsustainable heights, but:
How do we get more productive?
The most obvious plan is to junk government mandated luxuries dragging down productive businesses that seemed affordable when California homes were "worth" a median half mil, but now are clearly unafforable.
For example, to build on an insight of Gary Becker's in 1957, the EEOC and DOJ should restrict their lawsuits over purported patterns of discrimination in the demographic makeup of the workforce to organizations that enjoy some degree of monopoly power (police forces, utilities) and the like. In contrast, competitive firms are punished by the market for irrational discrimination, so they shouldn't be harassed by the federal government and encouraged to hire less productive workers in order to avoid discrimination lawsuits.
Posted by: Steve Sailer at Jan 24, 2009 4:49:59 PM
Personally, I'm more for letting companies fail through bankruptcy or liquidation. The US Government could help the process by providing a backstop in terms of whatever insurance and funding is needed to allow the process to go smoothly.
Posted by: kdp at Jan 24, 2009 5:36:48 PM
Anti-discrimination laws and suits do not require companies to hire less productive workers. Anti-discrimination is exactly that - a way to prevent companies from discriminating against people who are equally productive but happen to be black, or female, or (in some places) gay.
Eliminating anti-discrimination laws or suits will have exactly zero effect on the economy because the same number of people will either be employed or not employed - they will just be different people.
Posted by: Miriam at Jan 24, 2009 7:38:16 PM
"How do we get more productive?"
Steve,
One idea is to look at which states have done better than others and why. A few months ago, I looked at one state with an 8.8% unemployment rate at the time, and another with a 3.5% unemployment rate ("A Tale of Two States: Utah versus Rhode Island"). Two factors jumped out at me: energy costs and taxes on businesses. From the post:
According to The Tax Foundation, among the states, Utah ranks 17th in business tax climate, and Rhode Island ranks 50th. According to the Energy Information Agency, Utah had the 5th cheapest industrial electricity rates in July, with an average cost of 5.26 cents per kilowatt hour, and Rhode Island ranked 47th, with an average cost of 15.53 cents per kilowatt hour.
Utah's cheap energy, incidentally, came mainly from its plentiful coal. One way to increase productivity, it seems, would be to waive regulations restricting the use of coal in energy production.
Posted by: DaveinHackensack at Jan 24, 2009 8:00:47 PM
Thanks
Posted by: komik at Jan 24, 2009 8:16:34 PM
