Feldstein on Fiscal Policy

Martin Feldstein, a proponent of the recent fiscal stimulus, said it didn’t work.

Here are the facts. Tax rebates of $78 billion arrived in the second
quarter of the year. The government’s recent GDP figures show that the
level of consumer outlays only rose by an extra $12 billion, or 15% of
the lost revenue. The rest went into savings, including the paydown of
debt….Although press stories emphasizing that the rebates induced additional
consumer spending were technically correct, they missed the important
point that the spending rise was very small in comparison to the size
of the tax rebates.

It’s a peculiar op-ed, however, as he then goes on to say:

The small rise in spending in response to these tax rebates is similar
to what previous studies of one-time tax cuts found. It also
corresponds to what both basic economic theory and common experience
imply. Although someone who receives a permanent annual salary increase
of $1,000 typically would increase his annual spending by an almost
equally large amount, a $1,000 rise in wealth caused by a share price
increase or a tax rebate would raise spending only gradually over a
number of years.

Right.  But a short-term tax cut is exactly what Feldstein called for in an earlier op-ed.

The poor effects of the Bush tax rebate as fiscal stimulus, however, let Feldstein now attack the Obama plan for a $1000 tax rebate.  Nothing wrong with that – McCain has nothing better however – but what Feldstein doesn’t say is that if you follow the logic of his two op-eds (and this is not something I would necessarily buy into) the conclusion should actually be that fiscal stimulus would work better if it ran through government spending.


A tax rebate is theoretically supposed to have a multiplier effect. How is that captured in the 12/78 number? Philosophically, I believe in tax rebates, however, from a mathematical standpoint, I have to believe a tax rebate would have to be of an optimal size to induce a multiplier effect. ie, bigger than the average American's credit card debt, so that they pay it off and have leftover a small amount that would persuade them to buy a larger expenditure, eating back into their debt.

Also, the 12/78 number doesn't have the counterfactual right: in the absence of stimulus, consumer spending may well have fallen (or risen).

I'm sympathetic to Feldstein's argument, but I think he needs to answer the question "Compared to what?" We observe the world with the rebates and not the way the world would have been without the rebates.

The point of a stimulus isn't to affect the economy. The point is to make it appear to a gullible, uninformed public that the government is doing something about the problem. Typically, around the time the stimulus hits the downturn has run its course and the economy starts improving, the the gullible, uninformed public thinks that its government is doing something.

Just to clarify, I thought the Bush stimulus was a gimmick too, but because:

(a) They should have cut spending by the same amount, otherwise they are borrowing money from the private sector in order to give money to the private sector,


(b) It would have a supply-side effect if they had cut marginal tax rates, not given an ex post rebate.

Philosophically, I think that whenever the government is running a debt, we are in tax rebate territory.

The hypothetical baseline should be balanced income and spending. Now sure, that opens the whole crazy world of stratagems to reach a more balanced budget, including the incredibly irrational but popular notion that the way to balance the budget is to run a debt so large no one else can run it higher.

I'm afraid the floppy 'Norquists' (to coin a group) spent and tax-cut us into this position, where no answer is a good one. We were NOT supposed to run up a higher national debt in the growth part of the business cycle. And now, in the down part, we are in a spot.

In terms of what to do now ... I'm sure the 'Grovers' don't care ... as long as their taxes are cut.

So we have a Democrat campaigning on a tax rebate - and Ronald Reagan's Chief Economic advisor arguing that arguing that the rebate won't improve the economy.

Can anyone tell me what planet I'm on?

I'm not too confused about the two op-ed pieces. While the first one argues that a tax rebate that would kick in with growing unemployment and end after--a sort of semi-permanent income shock--would keep people spending, the second op-ed argues that the one-off rebate (a temporary income shock) didn't do much... as anticipated. Both are perfectly consistent with the Permanent Income Hypothesis.

Rex, is it clarifying to say that a rebate check generates a particular kind of deficit spending? The debt goes onto the Federal books, but the consumer gets to choose where the money goes.

That might work as a recession-curing stimulus in some circumstances but not others.

Rex, it is important to identify how the government finances it's debt. If the government issues bonds which are then bought by say, China, then that is a direct infusion of money into our economy - courtesy of the People's Republic.

A less cynical was to look at it is to say the government borrows from future generations to create a stimulus in the present.

Has there EVER been compelling evidence that short-term stimulus can dramatically influence the economy?

All the debate before the rebate was passed over about how much get spent in six months. We now have about one a half months data. Isn't this a little early to be drawing any strong conclusion one way or the other?

I basically worry about downward adjustment to tax rates because the baseline is so political. I'm sure that expiration of such a cut would be reported as "Hey, he wants to raise our taxes!"

The next question in my mind is if this sort of stimulus does prove to be inefficient, what does that do to the old arguments that we couldn't wait for infrastructure projects, because they couldn't be timely?

Make hay when the sun shines ... and maybe repair bridges when you've got to run a deficit anyway.

I suspect that dana is correct that extra savings are at least as useful as extra consumption. To which I'd add, given that the current problems are being driven by poor finance industry balance sheets, putting the money into banks and brokerages improved their balance sheets at just the right time, possibly saving the economy from a far worse fate, and thus possibly a far greater boon to the economy than mere consumption.

I'm also suspicious of the Keynesian idea that extra consumption is the best remedy or preventative for recession. It smacks of the broken window fallacy. Economic downturns, especially this one, tend to be driven by credit crunches. Extra consumption does not improve credit quality, but extra savings do.

Odograph said:

The next question in my mind is if this sort of stimulus does prove to be inefficient, what does that do to the old arguments that we couldn't wait for infrastructure projects, because they couldn't be timely?

I'm not sure what you're talking about here. If some fiscal conservative pooh poohed public works projects, on the grounds that it would take too long for that money to get "into circulation," then you're right that Feldstein's piece is inconsistent with such an argument--but that is exactly Tabarrok's point in this blog post.

Anyway, you and I are coming from such different worldviews that I can barely understand you. E.g. I think all bridges should be privatized. I'm guessing you don't. :)

I hope Alex and Tyler don't mind Odograph and me loitering on their property...

Odograph wrote:

Help me Bob ... what country has the highest percentage of privatized bridges, and how high is that privatized fraction?

I have no idea. I suspect we never hear about that country, because their bridges don't collapse and make the news.

I know a certain fraction of MR viewers like to reinforce such visions ... collectively ... but they seem far enough from probability for me to shake my head. To be honest, I think such views come from outliers who don't grasp the nature of their species. "Public works" are as old as man. There are stone age examples.

Oh come on. War is as old as man too. Am I allowed to be officially opposed to war?

Note that I'm not predicting we will have privatized bridges by fiscal 2010, I'm just saying it would make a lot more sense if we did.

"Note that I'm not predicting we will have privatized bridges by fiscal 2010, I'm just saying it would make a lot more sense if we did."

Why, so we can have some CEO securitizing the rights and then absconding with the profits in some corporate ponzi scheme a la Wall Street, banks of all colors, the real estate industry, etc.?

No f*cking thanks.

Welcome to our company which sells all kinds of eve isk.

Comments for this post are closed