When fiscal policy might make matters worse

From the new 4th edition of Cowen and Tabarrok, Modern Principles of Economics:

Increased spending and tax cuts have to be paid for. Thus, increased spending and tax cuts today will tend to be followed by decreased spending or tax increases tomorrow. When tomorrow comes and spending is reduced and taxes rise, aggregate demand will fall—this is one reason why long-run or net multipliers are smaller than short-run multipliers. Ideal fiscal policy will increase AD in bad times and pay off the bill in good times, as we show in Figure 37.5. Overall, if we can spend more in bad times when the multiplier is big and tax more in good times when the multiplier is small, the net effect will lead to higher GDP overall. Economists say that the ideal fiscal policy is counter-cyclical because when the economy is down the government should spend more, and when the economy is up the government should spend less.

Although counter-cyclical fiscal policy makes sense to economists, it often
doesn’t make sense to politicians or to voters. The views of economists violate a kind of “common sense” or folk wisdom, which says that in bad times the government should spend less and only in good times should the government spend more. After all, you and I spend less when times are bad and more when times are good, so shouldn’t the government behave similarly? If the government follows the “common sense” view, however, it will tend to make recessions deeper and booms larger, thereby making the economy more volatile, again as shown in Figure 37.5.

Even when governments do spend more in recessions, as economists suggest, they often don’t follow through on the second half of the prescription, which is to spend less during booms…This usually means that there is less room for expansionary fiscal policy when it is needed.

The 4th edition is just out, here is more information.



Do tax cuts have to be "paid for"? Even if you assume that it is a zero sum game and a tax cut means less revenue to say it must be "paid for" is a crime against the English language. If the job of government is to live within their budget/revenues (which it is) then there is no "paying for" a tax cut it is actually simply cutting expenses and wasteful spending. However experience shows us that tax cuts give citizens more of their own money which they spend, invest or save in a way that improves the economy and raises revenues. I think this is just scare tactics by politicians who do not want their slush funds taken away.

If we set tax revenues lower than government expenditures than that shortfall will have to be "paid for" in some form or fashion in the future.

It doesn't matter if one of us considers current government spending wasteful. We have to repay the amounts we borrow regardless of how wisely we spent the money.

"f we set tax revenues lower than government expenditures".

With a reduction in income tax rates it is reasonable and logical that revenues actually increase. Especially if the economy is being suppressed by high tax rates.

But that begs the question. "shortfall will have to be “paid for” in some form or fashion" is not accurate. If you make $50k last year and spend $50 you balannced your budget. If this year you make $40k you DON'T spend $50k !!! That is exactly what government is supposed to do. Live within their revenues. Don't borrow, don't set confiscatory tax rates, don't become oppressive because you cannot control spending.

Your crime against language is to use the word ‘logical’ when you mean ‘hopefully’. In current circumstances with debt to GDP ratios pushing at (or past) Reinhardt and Rogoff’s 90% warning level, there is no guarantee a tax cut will lead to faster growth and higher tax revenues, because people recognise the potential for future crises and hunker down, and market interest rates rise as the government swallows more capital resources. Prof Tabarrok is right, and you assume things are linear. In economics a linear path is only ever short term.

Joss, you have no argument so you must nitpick about a word you wouldn't have used.

I do not minimize the debt. I am opposed to deficit spending, which if you read what I said you would already know. But the point is the government does not have to spend more than it receives in revenue. If there is a tax cut there can be a comparable spending cut. Our problem is NOT that the people are under taxed it is that government overspends.

Shortfall does not have to be paid for! You are a statist and want to support that system I favor less government

Rubbish (I am anything but a statist). The issue we have here is that - I agree with you - deficit spending will eventually end us up in a very bad place. Prof. Tabarrok points out, and I teach my students, that it was supposed to be spend in the bad times, save in the good times. Governments seem to have forgotten this. I did not say deficit spending is fine. When students ask me how we went from £500 billion in debt in 2005 to £1.9 tn now I explain that Gordon Brown lifted spending so high in the good times that debt shot up when the tide went out. Bailing banks out was only part of it. My point, and it’s still valid, is that under current circumstances it is questionable that tax cuts will achieve the growth you state. Anyway, chin up, you aren’t faced with the prospect of a Corbyn government - thar really woul be deficit spending!

" it is questionable that tax cuts will achieve the growth you state."

Taxes are to business and productivity as a parasite is to a human. Parasites makes humans weak and sick and enough of them will kill you. Zero taxes have the exact opposite effect in that it makes the economy healthy just as zero parasites leaves the human healthy. So with taxes it is always a case of how sick do we want to make the economy? How much do we want to restrict it before we kill it entirely? How much money can we suck off the economy with taxes before we kill the goose that lays the golden eggs? My point is simply; why? Why not let the goose lay those eggs? Why not let the economy grow? Why not allow full employment and allow the workers to get rich? Why not? And of course almost every response against this must necessarily be a socialist response.

I think you have disqualified yourself from considered discourse by stating ‘almost every response against this must necessarily be a socialist response’. By predetermining the nature of any reply you deny value to any discourse. Ergo there is no point discussing anything with you. Why bother pointing out that there are numerous variables that need consideration - clearly your world is binary, right or wrong. I live in a different world, and never the twain shall meet, it seems. If you want an argument with people as polarised in their opinions I can point you in the right direction. If you want a discussion you need to be less antagonistic and more considered.

Yes, there is some point on the Laffer Curve where raising tax rates will result in lower tax revenues. While this point cannot be calculated exactly, economists that have looked at this estimate it is a marginal tax rate somewhere in the 60-70% range. So cutting rates from the current rate of around 40% WILL lower tax revenues.

What 'slush funds'? What exactly has been cut to pay for the most recent tax cut? What was cut to pay for Bush's tax cut and war? What was cut to pay for Reagan's tax cuts and cold war buildup?

Reagan's tax cut was intended to get us out of Carters recession. It worked and increased revenues. Sadly the Democrats reneged on their promise to cut spending and continued to spend more than the government received in revenues.

"slush funds" are all the amendments to laws passed that funnel money back into a congressman's district. And all the federal level spending that serves to reward special interests.

Cold war build up??? What is that exactly? The responsible defense posture is to be strong enough that no one will even consider attacking us. Would you prefer we choose to be weak enough so that more countries might consider attacking us? Funding the military is a constitutional responsibility whereas 90% of everything else the federal government does is neither a constitutional responsibility nor constitutional.

At any point will you attempt to answer the question or is your time travelling fax machine stuck on receiving 1985 Republican talking points?

I can only answer I cannot make you comprehend.

Yes, let's cut wasteful spending right now. No more regular trips to the so-called "Winter White House".

If they are going to say tax cuts have to be paid for, why don't they also say free trade agreements have to be paid for? Up until WWII tariffs accounted for nearly all of federal revenues (see the revenue breakdown chart at: http://metrocosm.com/history-of-us-taxes/ but of course up until WWII federal spending remained consistently at about 3% of GDP. But of course once government started taking more of the economy with income taxes etc, that all went away.

News flash: taxpayers don't just own their tax dollars; they own the debt too.

Why is restating what was in econ textbooks back in the 50s and 60s which sold for $20 when that was the labor cost to make paper, print, and bind books after the text and graphics were turned into offset plates "timely", when the cost of printing is still $20 and the cost of making the plates is much lower due to electronic publishing software cheap, or unnecessary for low volume books by laser printing with integrated bookbinding, but the bound books are now priced at $321.99. (Amazon $49) for the 3rd edition. 4th edition is available in a Kinko unbound edition for $187.99. After all, economic theory has just changed radically since 2015, or 1960, for that matter.

Since 2015, deficits no longer matter, while in 1960 and 2015 deficits mattered.

A book that sold for $20 in 1960 would cost around $170 today due to inflation.

Agreed. It is a shame that our media will not allow us to cut programs, which are clearly not needed, during this time of tremendous economic growth.

Why does the media hate America so much? My guess is that it is due to the universities. But it is complicated.

Tossing this idea out again for Tyler and anyone else....

Suppose we have no taxes at all? Roughly it would work like this:

1. The Fed figures how much hard currency it wants to create for monetary policy purposes and purchases bonds equal to that on the open market.
2. The Treasury funds all gov't spending by selling bonds on the market.
3. Some fines and 'sin taxes' would still remain as would user fees for things like national parks so the gov't wouldn't strictly have to borrow all of it's spending. (although you could redo some fines in the form of mandatory bond purchases....for example a bank that rips off its customers might, instead of of fining it $5B might be required to buy $50B of special ultra-low interest rate 50 year bonds and hold them for 25 years thereby tying up their capital in a less productive investment than their competitors).

Massive runaway inflation? I suspect not. The gov't would lean much more heavily on credit markets, but then without taxes demand and incomes would be higher allowing more savings to flow into credit markets. You would immediately see less push on entitlement programs and economic dead weight losses from inefficiencies in the tax code (which are more or less unavoidable no matter how intelligently you try to design tax policy) would likewise be gone. You would also remove a political incentive to oppose gov't spending that improves the economy by a perceived conflict between taxpayers and those on the other end of the spending.

In this universe almost everyone goes from taxpayer to bondholder either directly or indirectly. Bondholders have strong incentives to oppose inflation. However policies that boost the economy in the long run (say a well designed education program or R&D investment) would be supported because all things being equal a larger GDP is better to secure a given level of debt than a smaller GDP.

I think this simplifies the conversation. Right now there's a conversation about what the gov't should spend, but then a second conversation about how big the deficit should or shouldn't be. It really isn't clear at all to me that after more than a generation of warning about deficits, they really do have any real negative impact. If Reagan had made his deficits $75B/year less in the 1980's would our economy really be dramatically better today? Evidence?

Abolish taxes and the idea of a 'balanced budget' and you get rid of a red herring over a distracting accounting concept that is useful for a household or company but not a nation. Households and companies are limited in their jurisdiction. If you spend too much money, you have no legal claim on your boss. If Facebook squanders their money, they have no claim to some of Amazon's. There's also no claim on the future. Unless you have a contract, your boss is not obligated to keep you on the payroll when you're old. Netflix has no legal right to force you to keep subscribing 25 years from now. If Netflix is borrowing money today, a 25 year Netflix bond implies Netflix will still be able to sell something useful to enough people for the next few decades to pay it off. But it could very well be that 25 years from now entertainment is provided by some type of Amazon owned direct brain beam and Netflix has nothing of value. Gov'ts are a bit different. Their taxing and regulatory power means they don't have to worry about the future specifically. 25 years from now Amazon might trump Netflix or vice versa but whoever is winning will be paying taxes. The gov't is like the ultimate index fund preferred stock investor. It needn't pick a winner because the portfolio will automatically re-balance itself to the winner.

So if budget balance is not a real concept that has use for gov'ts why not get rid of it? The real concept is how much and how wisely the gov't spends. To the degree it does that well deficit financing needn't be an issue because GDP will always grow fast enough to keep debt-to-GDP at a constant level.

It's an interesting idea, but I'm not sure that it solves the issue of pro-cyclical policy.

......."Fiscal Policy" itself is the problem.

Fiscal-Policy = a tiny group of people in society imposing large, totally arbitrary interventions in the economy. They have neither the skill nor relevant knowledge to undertake any such actions in society.
Even professional economists widely disagree on proper 'fiscal-policy' under various circumstances.

The base premise of government Fiscal-Policy is absolutely fraudulent and foolish... but those at the levers of power just love to constantly jigger those levers. Hubris

You get fiscal policy whether you like it or not. The economy slips into a deep recession and people lose their jobs or take big investment losses, automatically their taxes go down. People opt for early retirement or try to get disability or go to the unemployment office and spending increases.

The base premise of government Fiscal-Policy is absolutely fraudulent and foolish… but those at the levers of power just love to constantly jigger those levers. Hubris

Except this just doesn't seem a very good model for how fiscal policy is done. It does with the Federal Reserve where you have a limited few people in command of a very specific lever with a very clear metric for success or failure. There is no 'fiscal policy' person in the legislature or executive. Instead you have different coalitions that have different priorities hence 'odd' outcomes. For example, if you have liberals who want more social spending and smaller deficits paid for by military cuts and upper income tax increases and conservatives who want tax cuts, military spending and lower deficits paid for by social spending cuts....you may end up with bigger deficits, more military and more social spending and tax cuts because a coalition will sacrifice a secondary priority (smaller deficits) to secure a primary priority (spending, tax cuts etc.).

We saw what bad fiscal policy does during the Great Depression.

When Bernanke started QE there were hordes of commenters here and on Fox News screaming "hyperinflation! They were wrong, because Bernanke's expertise was the Great Depression and he decided to do something different, and it worked!

So when people here spin theoretical tales, my first question is, "have you ever had to implement such a policy in the face of mass unemployment?" If not then GTFO.

One aspect of this fiscal policy problem is taxing actually increases the size of gov't. Instead of $1T the gov't ends up spending $2T because deficit hawks think a $1T deficit violates some type of spooky magic number so taxes of $1T are imposed, then $500B more in spending is needed to offset the drag of the taxes, then another $250B taxes get imposed because of said deficit hawks, then another $250B in spending and so on until you end up with a $2T rather than $1T gov't.

The other aspect of the cyclical policy problem is spending is artificially linked to taxpayers. A $1T stimulus bill is opposed in a downturn because taxpayers are worrying about the economy and adding a $1T tax bill seems like a bad move. BUT as we see the $1T tax bill never comes due and trying to get out of a recession by spending cuts just makes the recession worse....which 'solves' the taxpayers problem by getting him laid off and hence no longer paying any taxes!

If gov't is financed by bondholders, however, there is not an automatic conflict with spending. In a deep recession the bondholder is not worried about inflation but declining GDP is bad for the bond holder by increasing the risk of default but during the boom the bondholder frets about stimulative spending as that sparks inflation.

I think the critical flaw here is assuming creditors are going to willingly lend to a country with near-zero revenues that intends to "repay" it's borrowing with a perpetual increase in loans from the central bank.

It is immediately obvious that under this scenario the only way for the Federal Reserve to fight inflation is for it to restrain government spending. Inflation expectations must be higher under this scheme.

And once inflation becomes a problem, cutting government spending sufficiently to curtail it may not be feasible. Can a country stop paying social security or disband it's military to fight inflation?

The Central Bank here isn't really changing any policy. It isn't loaning anything to the gov't. When the Fed wants to increase the money supply, it goes to the bond market and buys bonds. Just like a broker might do for a client, it buys bonds for the best price possible on the market.

If the Fed thinks inflation is increasing, it raises interest rates by curtailing its purchasing of short term bonds. There's no 'lending' to the federal gov't. Rising inflationary expectations would hurt the bond market, lowering the value of existing bonds which would be like a tax increase on the many different people and groups that would own bonds under this system.

"I think the critical flaw here is assuming creditors are going to willingly lend to a country with near-zero revenues that intends to “repay”"

Do they have a choice? Let's say you think this system is crazy, so what are you going to do with your untaxed paycheck? Well you're not going to buy bonds, fine. So you stick your savings in a bank. The bank is going to buy bonds. Or you go out and buy stuff, well as you go on a consumption spree you're rising profits for businesses all around you who sooner or later will start saving some of that money by buying bonds.

Keep in mind the US has had a national debt for well over 100 years now. While there's been some surpluses there's never been a 'pay off' moment. Bond holders are all mortal people at the end of the day, generations of bond holders have purchased, held and then cashed in bonds that were paid for by the issuing of more bonds. Also nothing in this system would preclude reintroducing taxes in the future so someone considering buying and holding a bond for 30 years today would have t consider 30 years from now the gov't could pay him off by issuing another 30 year bond to some other investor OR by imposing taxes if this idea is deemed a failure. In other words, that's the same thing someone buying a 30 year bond today considers.

There are many examples of 'counter intuitive' forces that apply in the realm of public economics. In business, the more dollars that a product draws, the more successful it is, the more the corporation will build up the business around it, the more the managers will get paid and so on. On the other hand, if a social concern- say crime- if getting out of hand then there are forces that draw dollars to address that issue. Task forces are created, officers added, salaries of managers increase to follow union protocol for job descriptions. Meanwhile the truly successful police forces that are reducing/managing public safety get their budgets cut and are pressured to consolidate with other Metro services.
One could speculate that the adopted notion from commercial business forces that equate a big budget to a successful manager has lead to bureaucratic bloating in the public sector.

You're assuming the crime rate has dropped because the police department is successful, hence the cause of the drop. But if that is the case then in the long run there shouldn't be an issue. If the town cuts the police department because they think there's less need for police now that crime is down, they'll see crime go up again. In the end they will 'learn' the police department must be maintained at a certain size even if there's no crime at all.

On the flip side if crime remains low despite the reduced police department budget then why not cut the waste? This happens in business too. If a product 'sells itself' a business will realize they don't need the marketing budget for it and the marketing department will get cut despite how successful sales are.

Assigning, for the purpose of bank capital requirements, a 0% risk weight to the sovereign as regulators have done, dangerously and non-transparently subsidizes government borrowings, funds managed by bureaucrats not directly responsible for the repayment; prioritizing it over for instance loans to entrepreneurs who could create the future jobs for our youth. That is sheer dumb statist lunacy.


What exactly then should a bank be keeping for low risk capital?

Bitcoin, duh.

All other assets are obsolete.

All this, of course, implies fiscal policy has a large impact. The evidence for this seems to be lacking. (Japan since 1990/UK post 2007).

There is a good theoretical reason why this is the case: government borrowing will mainly just reduce other components of AD. The only effect is second order: upward pressure on interest rates. In the neo-wicksellian view this implies a more expansionary monetary policy if nominal interest rates are held constant. In the Monetarist/NGDP view, higher interest rates mean a higher opportunity cost of holding money, so velocity rises. Why bother using high opportunity cost fiscal policy with a small effect, when the printing press is available?

Monetary policy should drive AD, fiscal policy in general does not.

If evidence for good results from fiscal stimulus are indeed lacking, that would make it doubly bad in a growth economy - especially pointless and still (in this case very) expensive.

You're assuming a good pure case of fiscal policy, which has never really happened.

The argument against fiscal policy is all gov't spending should be done on a cost-benefit basis. If the benefit is more than the cost, it should happen whether or not there happens to be a recession at the moment. If gov't spending was done on that basis purely, then it would be very hard to do fiscal policy since what would the gov't spend? But then again fiscal policy would probably be automatic. When the economy is booming labor costs go up as well as commodity costs. As a result a proposed project like repaving a road will see increase costs which may put it on the bad side of a cost-benefit analysis. But when a recession strikes borrowing, supply and even labor cost can fall switching the verdict to yes on this spending.

Reality check, at any given time gov't spending is a mix of positive projects and negative ones leaving on the table a lot of unfunded projects with positive and negative net benefits. So during any recession you can always find some positive things gov't should spend money on. Strictly speaking those same things might have been worth spending on during the booms but for whatever reason they weren't.

Second reality check, we are talking gov't spending here meaning ACTUAL GOVT SPENDING. That means gov't literally buying a direct good or service. This is not the same thing as transfer payments like social security, food stamps, even Medicare. that gets a bit complicated since it isn't really the gov't doing the demanding but the consumer who gets the transfer.

I think we mostly agree. ROI is important, but more so in expansion, when crowding out and opportunity costs become real factors. ROI becomes a lower bar when aggregate demand is (way) down.

.. I am sure the Modern Principles of Economics, 4th edition, puts that more clearly.

If the economy is near capacity the ROI should address the issue. Crowding out is just a different way of saying interest rates would be higher, higher interest rates means any project would have a higher cost which would make marginal projects switch from a positive ROI to a negative one thereby giving you 'fiscal policy' of spending more in recessions and less in booms.

Isn't crowding out sometimes used in a more general sense? Competition for employees, resources, broadly speaking attention?

A freeway expansion is easier when resources, and congestion, are slack.

Which implies fiscal policy overlaps. During periods of slck, the ROI's will increase because costs will be lower. A country following a strict ROI only policy will still appear to have something like a Keynesian policy because spending would increase during deep recessions and reverse in booms.

But unlike private sector ROI's, I don't think the macro government can ignore economy wide effects. When Amazon spends a afew billion to build a new headquarters, some of that money will come back in the form of Amazon purchases made by employees and vendors who get those contracts. But if income goes up because of a gov't stimulus it isn't trivial to note that at least 20% of that comes back thru taxes immediately.

A pox on both (Democrats and Republicans) their houses.

Morituri Te Salutant.

That sir, is a partisan CYA.

You know the history. Bill Clinton signing, not fighting, balanced budgets. Dick Cheney declaring that deficits didn't matter. Medicare Part D. Obama endorsing, and presiding over something quite like "ideal" policy, only to have it blown to hell again by a fresh crop of "deficits don't matter" Republicans.

Symmetry is here again the devil's argument. It hides and distorts, it does not reveal.

You're playing with me. Right? "Ideal" = a massive tax increase and Medicaid expansions called ACA; additional $9.6 trillion national debt (end FY 2008 - $10T/67% GDP; end FY 2016 - $19.6T/105% GDP)2016; $900 billion "infrastructure money that built/fixed nada; $4+ trillion Fed quantitative easing, . . .

BTW You're correct. Dubya was the worst thing that happened to the GOP and the right. You left out the unnecessary and vile Iraq War and his part in inflating the housing bubble and subprime crisis that led to the 2008 financial catastrophe.

You need a graphic to see it.


Look at the deficits, 2007 to 2014.

Extend that trend line and you get "ideal" surpluses.

Nobody's right.

Data mining/cherry-picking to win an argument . . . .

You left out the part where Obama saved the World.

"This was the moment when the rise of the oceans began to slow . . . "

I think data mining is picking out one or two numbers, not looking at the long term trend.

Tyler's graphic above is an idealized long term trend, my link is to the actual long term trendm

ACA was certainly Obama's doing. But according to CBO taxes raised more than offset new spending. And actual spending under ACA was lower than originally projected. So from purely the perspective of it's impact on the federal deficit, ACA moved things in the right direction (which is why the full repeal bills were scored as deficit increasing).

The debt accumulation over Obama's term was mostly driven by inherited factors - an initial structural deficit + the Great Recession.

Policies that impacted the deficit:

- ACA reduced it by $143B

- "Stimulus" increased it by $800B (without scoring it "dynamically")

- Sequester reduced it ~$600B

- Make "Bush tax cuts permanent" increased it ~$1.6T

There's probably tons of other nickle and dime stuff to account for but the big things Obama did added to the Debt by around $1 Trillion, almost all of that by extending tax rates already in effect when he came into office.

Out of all of these, I say we keep the Sequester.

Tbe sequester was not ideal, in that it did not target low ROI spending, but it did certainly put us one something like the "ideal" path.

Maybe it really is better (if not best) when we have Democratic Presidents and an unruly Republican Congress.

Best would be a government that looked at ROI.

In recent history Dem presidents and Rep Congresses have produced the best fiscal policy: 1994-2000 and 2010-2016 come to mind.

"You left out the unnecessary and vile Iraq War and his part in inflating the housing bubble and subprime crisis that led to the 2008 financial catastrophe."

It is not so simple.

Oh, and for extra credit, how much energy did you spend fighting Obama's counter-cyclical stimulus (ideal) and how many lines have you actually committed to fighting this pro-cyclical disaster?

If you acquiesce, throw up hands, pretend it is both sides, say ah well public choice, all those excuses make you part of the problem.

You aren't demanding the ideal.

Don't you have it backwards?

We're supposed to have AUSTERITY during a recession,


Increased Military spending and increased infrastructure spending, tax cuts and more debt during periods of 4.1 percent unemployment.

Paul Ryan says so.

"Paul Ryan on Wednesday said "nobody knows" whether Republicans' tax bill would pay for itself, after GOP leaders argued for months that it would." http://www.businessinsider.com/paul-ryan-trump-tax-reform-bill-debt-2017-12

Ryan is telling the truth. Unfortunately, the concept of "tax cuts paying for themselves" is magical thinking, since enormous business and personal mental energy is expended in attempting to lower tax obligations as much as possible, no matter what the tax policy might be.

I think the ideal policy defended by Tyler and Alex would avoid austerity during recessions. Basically, you were supposed to run a responsible fiscal policy during boom times, i.e., spend reasonably to save for the bad times so you can apply counter-cycle policies.

Shouldn't this chart be labeled "speculative"?

No it shouldn't unless you can put forth a plausible scenario where this would not be the effect all else being equal.

Not to put a total damper on the theories behind this chart, but it looks suspiciously like this chart.

Now, the original proponents in 2009 will hand-have that away by saying "Oh, we just didn't know how bad it was really at the time we made the projections!", but doesn't that indicate a need for a lot more humility when confidently deciding macro-economists are applying "ideal fiscal policy". It doesn't appear that so far in the real world, they can determine in time when the booms and the busts are happening in order to make the models in their graphs line up properly.

That's quite an empirical issue, as the proponents of this fiscal policy all predicted the opposite of the actual results of various "austerity" measures, making me think they might not have the full story here....

The chart, of course, was built by averaging how previous recessions behaved. Of course that's all well and good unless you're dealing with the worst recession in modern history, in which case the average of previous recessions is not what should be included in your model.

So what you're saying is "Oh, we just didn’t know how bad it was really at the time we made the projections!" Huh, at least some of us can predict things accurately based on our models...

The counter prediction was not higher unemployment/lower inflation with the stimulus but inflation.

In assessing a model you ask not did it's predictions fail but how did they fail. Is the failure nonetheless consistent with the model or inconsistent with the model? Simple gravity says drop a feather off a building and it will fall to the ground. Reality is because the feather has a large surface area to density it will float slowly, even sometimes catching a gust of wind up. Does the failure of the simple prediction indicate the model is wrong? No. But if instead of falling the feather shots upward eventually leaving the earth then there's something very wrong with the model.

Out of threading space to reply directly, but countering the failure of one model to predict something accurately with the failure of someone else's model to predict something accurately just continues to argue for my original point, which was "a need for a lot more humility when confidently deciding macro-economists are applying 'ideal fiscal policy'."

Macro-economic models in general suck for predicting the future. They can be somewhat useful in specific situations for analyzing the past, but to say we should be taking large actions to affect entire countries (or more) based on a prediction from a model which doesn't match empirical reality when previously used by it's proponents as a prediction model is to claim too much utility for a model wherein it doesn't exist.

How about the model proponents spend some time winning bets about the future themselves using their model before arguing everyone else needs to bet everyone's future on their model? The underlying assumption seems to be that we must trust SOME model to control the economy based on, so how about this one, but there is more of a need for humility of those with their hands on the levers of power than there is for more control.

A building is on fire. Old school fire department says "lets start spraying water on it now". Another person says "hang on, this building might be filled with special chemicals that explode when wet, water might make it worse".

These models lead to two radically different conclusions:

Water is right: Flames will decrease and fire will go out faster
Water is wrong: Big explosion and possibly even more fire.

You are correct, it would be helpful if the old school fire department could tell you how big and long the fire would be if you don't put water on it and how fast water will bring it under control Likewise it would be helpful to know how big an explosion would come from the water is wrong model.

So if you actually put water on the fire and you don't get an explosion you haven't fully confirmed the first model but you've eliminated the opposite model. The critic could still say something like "perhaps the building had just enough water exploding chemical in it to keep the fire burning but not make a noticeable explosion....maybe the fire went out no sooner than it would have otherwise went out if you had let it burn itself out on its own". I think that's a valid question and worth getting into the weeds by asking ourselves just how good are our burning building models and how could we tell if that's really what happened. But usually that graph is tossed out there as a show stopper to somehow prove stimulus failed when in fact the real model failure was with the anti-stimulus side.

Notice how the graph doesn't just predict the actual unemployment but it also makes other predictions. For example it predicted the shape of unemployment into the future peaking in a hump then falling. How much of the graph really failed? If the critics of stimulus produced graphs ahead of time what would they show? Did they give us enough information to produce a graph of their theories and compare it to what happened? I suspect they didn't. If you take a few shots at the basket and land some but miss others you automatically get more points than someone who claims they are a better free thrower but decline to take any shots.

Macro-economic models in general suck for predicting the future. They can be somewhat useful in specific situations for analyzing the past, but to say we should be taking large actions to affect entire countries (or more) based on a prediction from a model which doesn’t match empirical reality when previously used by it’s proponents as a prediction model is to claim too much utility for a model wherein it doesn’t exist.

Bringing it home, using the burning building example, we probably don't have great models that prove how long and how big a fire will get in a burning building. Likewise we probably have very poor models to tell us how much of that fire will get decreased if we shoot water at it. But we have very good reason to believe our models are accurate enough to tell us that shooting water at a burning building will decrease the fire in terms of size and time than not shooting water at it. Hence fire departments operate without billion dollar supercomputers mounted in their trucks to model the dynamics of flame in buildings they are called to.

The dispute over models working better will become relevant in contexts where we push beyond that. For example, should we shoot water from ten hoses or should we use 3 hoses of water mixed with a special new flame retardant? Then I could see the argument that we need better models of fire because the second option is going to be much more expensive than regular water but might be worth it. Or if someone proposed shooting a billion hoses of water at a fire we could also point out that might be so much water we start causing worse problems like massive landslides. But in terms of the 2008 stimulus the debate was not with a proposal for a $250T stimulus package nor was it between two different $1T stimulus packages with different provisions. It was between a stimulus or no stimulus and like the fire that's a much simpler question of do you let the building burn itself our or try to contain the fire. There I think the models work pretty well

As you apparently glazed over it, allow me to repeat:
That’s quite an empirical issue, as the proponents of this fiscal policy all predicted the opposite of the actual results of various “austerity” measures, making me think they might not have the full story here….

To use your example, we had a fire, one group predicted how it would turn out if austerity was passed. Their predictions were exactly and totally wrong, as in opposite direction of results wrong, now you want to claim their predictions are better than nothing. Nope, their predictions were literally worse than nothing. At least with nothing, you wouldn't have made things even worse by following their completely wrong advice.

Seems to that until the bond buyers shun t-bills the deficit cannot be addressed because the politics are bad, people like programs and don't like taxes. Democrats may be the better bet to cut the deficit because they would like to tax the rich and sensibly cut defense spending, but they also like to give money to everyone but the rich.

I suspect bond buyers are incapable of shunning T-bills. We see this dynamic with China. China sells lots of goods to the US, it gets lots of dollars. Right now China buys t-bills because it doesn't have anything else it wants to do with those dollars but suppose they shun t-bills. What do they do then? Buy stuff from the US? OK now businesses have lots of dollars, what do they do with them? Buy Eurobonds? OK now Europe has lots of dollars? Sooner or later these dollars are going to end up in a bank or company or fund which is going to buy T-bills.

What happened in Ireland during the last recession? Seemed like prices and wages (even public sector wages) were flexible and austerity measures allowed them to recover.

Can stimulative fiscal policy that includes automatic stabilizers slow the adjustment of wages and prices and prolong a recession and slow a recovery? Unless you can generate enough inflation that fools people into thinking that real prices and real wages haven't adjusted.

Shouldn't the test of government spending be about whether it is a proper role for government and does the "investment" make sense. Something more along the lines of the NPV of government investments rather than the proper timing of expenditures. (Not that many government expenditures could pass this test.)

Isn't the whole notion of stepping on the gas or hitting the brake a poor way to run fiscal or monetary policy? Are both a source of potential abuse and the enemy of allowing private markets to plan. When shocks hit the economy which is quicker to respond correctly to the signals - a free market or politicians?

In 2008 a slight increase in oil prices was seen by the Fed as inflationary. They started raising interest rates at the same time a record number of adjustable rate mortgages were reset. Financial firms who thought they had hedged against mortgage default risk were overwhelmed. California suffered from poor water and energy policies (not to mention general stupidity) suffered. Florida saw a drop in tourism. The combination of higher oil prices, higher interest rates, and a collapsing housing market meant a drop in sales (especially profitable truck sales) for the auto industry. The auto industry, already a sick old man, teetered on bankruptcy causing ripples throughout the Midwest economy. How would the model that Cowen and Tabarrok mention have helped prevent this? In my argument, the Fed's desire to stabilize the economy gave oxygen to ignite the embers of the housing crisis.

Lastly, if the government runs a deficit what happens to those debt payments. Does the money just disappear or does it become income to debt holders? Running deficits, even large deficits, isn't necessarily a drain on the economy. In contrast, running around spending money like a drunken sailor probably isn't a great idea, even if the economy is doing poorly or well

"Austerity was necessary to correct Ireland’s public finances, but it was not responsible for the rapid recovery of the country’s economy subsequently, according to a major new analysis of the economic crash and recovery.
The book, Austerity and Recovery in Ireland: Europe’s Poster Child and the Great Recession”, is published by Oxford University Press, and will be launched today by the former governor of the Central Bank Dr Patrick Honohan.
Instead of crediting austerity with the recovery, the book credits Ireland’s strong export industries and buoyancy in the country’s top export markets, along with European Central Bank quantitative easing and historically low interest rates.
Together these factors helped to stabilise the banking system and supported the recovery, according to the book’s contributors who include economists, social scientists, political scientists and other “internationally acknowledged scholars”.

If wishes were horses beggars would ride. https://www.irishtimes.com/news/politics/austerity-is-not-responsible-for-the-recovery-experts-claim-1.2942139

Irish austerity meant lower deficits. Firms seeking to locate or expand in Ireland would know that future taxes would need to be raised to pay for any current deficits the Irish might incur without austerity. If these firms know that taxes in Ireland are low and will remain low by international standards they are more likely to expand today. The authors in the book you link to fail to see that the strong export-driven industries that drove the Irish recovery are there and growing because of the austerity policies - because of the expectation of low taxes today and in the future.

The Irish are tied to the Euro so they can not use inflation to adjust wages and prices. By encouraging flexible wages and prices the Irish economy was able to adjust rather quickly.

Ireland had to seek ways to increase productivity if they wanted to expand exports. The drive for austerity was also a drive for higher productivity and efficiency. Simply they had limited paths to take to make the economy more dynamic and growing. The authors acknowledge this but claim Ireland didn't go far enough in increasing efficiencies. So the Irish weren't austere enough?

The Irish did have the advantage of many guest workers so that the total population could adjust. But that is just an argument about flexibility in labor markets and less an issue of austerity measures.

A third of Irish debt was related to the banking industry, and the ECB, not Ireland, was the one that pulled that one out of the fire. Second, how much of Irish GDP growth is IP offshore assets parked there to avoid or minimize taxes. Counts in the GDP numbers, even though it does not involve anyone, other than bankers or lawyers, doing anything.

You might want to look at the link referenced in my earlier comment, or do some simple research.

I suggest you read the book you referenced.

Then look up austerity

Then look up government deficits

Then look up fiscal policy

Then try an intro economics course

I did, but you didn't.

I don't see any special recovery for Ireland


I see Ireland sunk a lot during the recession and 'recovery' now means getting back to about where you were before the crash. But what really jumps out is Ireland surging up in the early 2000's. Without digging deeper I'd say Ireland is a special case about being in the right place at right time as a special niche tax haven between the EU and UK. Might that work for other small economies just outside larger ones? Sure but does that provide useful lessons for major economies?

"tax cuts have to be paid for"

stinking hacks

As should be obvious, only spending needs to paid for. Taxation determines when spending is paid for. Cuts in rates of taxation do not create new liabilities.

You're making some kind of philosophical point, but in practice there is no difference between a tax cut and a spending increase. Both increase the deficit.

No, tax cuts do not increase the deficit. Only spending does that . Tax cuts reduce revenue but they do not increase outlays. Indeed “in practice” increased tax revenues induce more spending. But, even if we accept your argument, then why not also recognize that we have to pay for tax expenditures like tax exempt universities? There is a reason why hacks equate tax cuts with spending increases and pretend tax expenditures don’t increase. And being sloppy with basic logic doesn’t help a thing.

Regarding tax expenditures, yes, of course.

Regarding the deficit, tax cuts only increase revenue if we're on the left side of the Laffer curve. Otherwise, they decrease revenue. All evidence points to the latter being the case.

The only problem with your graph is that is a completely unsupported load of crap.

It's great that you can put Dem Spending "Theory" onto a nice-looking graph, so that Dems can point to it and say nice things about you. But that doesn't make it a reality.

Recessions come and go, and the primary factor there (besides randomness) is people's willingness to hire other people, which is affected almost mostly by regulation/laws and optimism. Hence the Trump Effect. Government over-spending has many terrible ramifications but it has very little effect here.

Your graph does nothing except allow Dems to point and say "See, we should have overspent more during the lost Obame years!"

Nice job, chief.

The 'Trump effect' seems to the economy carrying on the Obama boom. It's almost a perfect straight line:


Republicans hated Keynesian economics when it told them to spend and now they hate it when it tells them not to.

The sad thing is that they have no, zero, nada, economic theory for this current b.s.

A stimulus *bigger* than Obama's, in a time of expansion and low unemployment.

Hmm. I say "no, zero, nada" and then I find one, economically literate and a bit lefty:


I would say it is a qualified endorsement, but I think I will stay conventionally counter-cyclical myself.

Meanwhile, in the real world...

Republicans are deficit hawks when the Dems are in power. They’re hypocrites. Great, you’ve made your point. Did anyone disagree with this, at all? I mean literally at all in the comments? You’re tilting at windmills.

Crude Keynsian economics has been demolished. Japan is the prime example but there are others. If you want to talk Econ, great let’s talk Econ.

You could start with Bernake on Japan, or Friedman and Schwartz (flawed but opened the door towards the real answer) on the Great Depression.

Regardless, fiscal policy is a red herring. Sure, there’s a theory floating around about how fiscal policy can be important due to political and institutional capital constraints on central banks, but I seriously doubt that is what you are alluding to. Bernake implied this while he was the Chair btw.

The ACA is not deficit neutral or reducing. That’s okay, it can be debated on the policy merits alone in good faith. I’m not a fan personally but reasonable people can disagree on its merits. The deficit reduction comes from taxes and Medicare Doc fixes that were only meant to game the CBO score. Wake me up when O’s Cadillac tax hits. I won’t hold my breath.

You want ideal? Great, let’s push for a regime change at the Federal Reserve. It’s overdue and is probably the most important thing the government can do for the welfare of its citizens. For some reason that’s never on either tribes’ priority list....

Maybe because it has nothing to do with creating winners and losers, or raising or lowering different groups’ status.

Oh well. Back to partisan sniping and blaming The Other.

You will notice that the area under the curve is the same with or without fiscal policy. What determines GDP growth is not tricks from fiscal or monetary policy. "shock absorbers" are not used on race cars, for good reason, nor is "money illusion" (monetary policy) anything you can bank on reliably. Making life comfortable for the unemployed does not work, it only makes them lazy.

Yeah, those lazy unemployed should get a job when no one is hiring or employers are laying off.

Yea ok, the Great Vacation theory of 2008. All in the sudden a huge portion of the population just decided to stop working because they were suddenly lazy whereas they weren't just before. On top of this, they decided to just stop working even though they had no serious amount of savings or assets to fall back on, their unemployment caused them measurable financial harm (foreclosed homes, ruined credit scores etc).

" . . .“shock absorbers” are not used on race cars, for good reason, . . . "

I am sure F1 and Nascar suspension engineers will be surprised to discover this.

@Bill, @Boonton - you are aware that the labor force participation rate went down after 2008? So yeah, the Boomers (including myself) took a permanent vacation rather than come back to work after a routine balance sheet recession.

@Corsair - of course F1 and Nascar does not use suspension, like a conventional sedan 'traveling sofa' car, see (screen scrape) "May 14, 2009 - Needless to say, Formula One cars owe a lot of their impressive on-track performances to their multi-link type of suspension. In fact, the stiffer suspension encountered on these machineries is practically the most important feature that maximizes the use of the powerful 750+ F1 engine"

Only problem, those not participating in the labor force cannot get unemployment benefits....so how again were they suddenly made 'lazy'?

Roy L has an interesting observation in a less interesting comment: "You will notice that the area under the curve is the same with or without fiscal policy."

The assumption here is the economic growth is a long run straight line with booms and busts just being temporary deviations from the straight line. Kind of like a long drive on an interstate highway. You stay in your lane but your car does sway a bit side to side since you're not always driving with 100% attention.

But is this just 'car swaying' inside a lane? I suspect there's real evidence that the last recession was so deep that it probably did do permanent damage to the economy. Our GDP going forward will be lower than what it should have been or could have been. On the other hand, the stimulus we did do kept a Great Recession event from turning into a Great Depression.

But is it optimal to iron out the up and down entirely? I'm not so sure. An older theory of economics held that busts were helpful for removing overcapacity from the economy. A lot of destruction in the economy happens gradually. Record companies, for example, are still around but their power has declined gradually as digital music has dramatically altered the industry. But maybe sometimes it's helpful if the destruction is sudden and dramatic, like Enron or Lehman Brothers blowing up suddenly. Perhaps you sometimes need large industries to blow up so the economy can rebuild from scratch just as sometimes you should just toss out everything cluttering your room then add back stuff rather than try to clean it.

@Boonton - " I’m not so sure" - but this humility is not shared by most economists, who view Keynesianism and its close cousin Monetarism as a meal ticket. They are quite sure, pace the Austrians, that shock absorbers and money non-neutrality work to increase real GDP.

I'm less 'not sure' than you may think. I'm sure the proper response to a deep recession is stimulus both monetary and fiscal. I have not heard a convincing case otherwise from Austrians and when pressed they end up talking in circles (example, try to nail down what exactly is 'malinvestment', for it to make sense as a concept it cannot simply be an unwise investment).

Where I think the no sure comes in is the degree. I think a very wavy line is harmful, so that implies we should have fewer extreme waves. But is a straight line optimal? I'm not so sure.

“The boom, not the slump, is the time for austerity at the Treasury,” wrote John Maynard Keynes. “

Krugman makes the same point. This is no time for the government to be profligate.


No mention of the Sumner critique of fiscal policy? Surely you can't discuss fiscal policy without mentioning this.

For those who don't know about this Sumner critique it goes like the following; If the CB is working to manage inflation/aggregate demand to a certain target then any attempt to undertake fiscal expansion will be negated by tightening of monetary policy by the CB. If however the CB is tasked with managing overall aggregate demand then there is no need for fiscal policy, the CB can do it by loosening monetary conditions, all fiscal policy would achieve is higher government debt. Of course sophisticates talk about the zero bound at this point, but we have never been at the zero bound in any developed country, and anyway as long as the CB owns a printing press monetary policy can always be made more loose simply by printing more money.

This critique assumes the CB is unbiased in their mission to avoid inflation and unemployment. History and culture seems to demonstrate the CB is biased, opting to go down harder on inflation but underemployment. From that perspective fiscal policy is a nice counter-bias since legislatures presumably would have the opposite bias, trying to pounce on unemployment first but less willing to embrace austerity to avoid inflation

I don’t see how your point invalidates the Sumner critique. If fiscal policy works it raises inflation, which will then encourage the CB to clamp down, raising interest rates to offset inflation. This isn’t even theoretical, just look how the Fed is itching to normalise rates despite low inflation. Any hint of actually higher inflation trend and rates would be hiked already.

That would be applicable at a marginal case where the CB feels the economy is at capacity but the legislature feels it is below.

Every jump in the deficit is followed immediately by recession. It is in the chart since 1980, a period encompassing four recession. On the chart. Jan 1, the big jump in deficit is for the following year, which always has the blue mark on your fred chart. I seriously doubt that soe economist somewhere is picking up a short term boost in GDP a few months before the recession.

More likely, we fool ourselves and the deficit is always a bill due and payable for imbalances in the oat.

The deficit vanished in the late 90's and turned to a surplus yet there was recession in 2001.

The the deficits started rising then one year later the recession.


But the Bubba surplus was good, the deficit not so bad and the subsequent recession was actually revised away if you look at fourth revision real GDP.

There is no evidence of countercyclical. If there was the recession would be random, but they happen on presidential regime change. The federal budget is basically imbalanced, the Bubba period really was a king of exception. We have generational depressions to rebalance them, usually defaulting somewhere along the way.

I'm not really seeing the pattern you are saying. Example, the deficit appears pretty stable in the late 80's yet recession in 1990. Likewise right after 2000 the deficit shot up yet no recession yet around 2008 the deficit was falling and bam, recession.

I'm not so sure the dot-com bust was a "recession." Day-trading casinos and companies with zero revenues were liquidated because they were crap. The interesting part is how they got so much money in the first place.

poiticians? which party is in power now...remind yourself...you rarely show the willingness to name names but you don't mind blaming both parties, do you?

Would you (Tyler) consider exchanging the term "tax cuts" for "revenue reductions?"

Do we really observe a **reduction of revenues** in the Federal Fisc over the past umpteen (and more) years?

Suppose we had a statute that limited the amount by which the Treasury could increase the amount borrowed in any period to the amount of the increase in revenues received.in the same period? Effect?

Very conventional take.

While I prefer balanced federal budgets and a much smaller federal government, what is, is.

A modern textbook should at least mention Japan's successful use of helicopter drops to exit the Great Depression, unique among developed nations.

In addition, the Bank of Japan has now monetized, or bought back, 45% of Japan's JGB, and it is still going.

Where is the inflation in Japan? Right there with the Cleveland Browns.

There are non-conventional options for central banks to pursue, and they may work better than conventional options. Especially when zero-bound is hit (which may be early in the next recession).

Surely, that is worth mentioning.


The algorithm here seems pretty simple:

1. Add stimulus.

2. Check, is inflation picking up?
if yes, go to 3. if no go to 1.

3. Stop adding stimulus.

Is inflation too high?
if yes go to 4, if no go to 3

4. Pull back on stimulus.

But while this is pretty simple and would normally provide a good test of economic theories most countries refuse to do it. Instead #1 is done, then things stop because of fuzzy and unclear fears (zero percent interest is unnatural, 90% debt to GDP is some magic evil number to cross, rather than entertain numbers we should have theories based on qualitative assertions from pundits (i.e. 'regulatory uncertainty' causes recessions)). sort of like a patient who takes a single antibiotic pill and doesn't notice he is cured and then declares it a failure and decides he must start reading homeopathy sites

The problem is that governments want to do more than merely hand out checks.

They want to create long lasting social programs with stable and predictable outlays.

Imagine if we adjusted Social Security payments based on the business cycle. People would be furious.

Well actually we do. Remember Social Security gives you the option to put off retirement and get a bigger monthly check or take early retirement and take a smaller check. If you have a big recession that is probably going to drive more people to opt for early retirement and likewise a boom probably pulls some people to delay retirement. It's nothing like saying everyone's SSI checks will have a swing based on the business cycle but it is a fiscal swing nonetheless. Also don't forget that deep recessions often end up with extensions passed for unemployment insurance.

Yes, but a proper monetary policy will offset any distortions from fiscal policy. Short term, no problem. Long term, we have to cover the vig. The vig is going to get big.

I'm not sure what this means. Let's say you have a gov't that recklessly stimulates on the fiscal side. the Central Bank takes the opposite view and contracts money supply by selling bonds just as the gov't is also selling bonds to finance stimulus.

If the central bank is right, the contracting money supply should cause interest rates to spike and it will get tougher for the gov't to continue with fiscal stimulus. If the central bank is wrong investors trying to buy risk free assets should mop up all the bonds the CB is selling as well as what the gov't is issuing.

It's not really clear to me who is more powerful. The CB can only contract to the point it sells all of its bonds for cash.

I think currently a lot of things are going into very difficult phase, so that’s where we need to be extremely wise and watchful. I don’t get too much into the fiscal policy thing, but we need to ensure that we make our choice of investment right.

The Crypto world is ideal for investment and upcoming ICOs too are very much likable thing for all. I say look at Coins4Favors, it got all the stuff that makes you feel happy around with in terms of strong concept and equally capable team of experts running through. With Presale starting from 1st of March, it is not to be missed opportunity!

The 4th edition is just out

So the bookstore(which is cut in on the deal) will not let me return my perfectly new-looking textbook for half-price to sell to someone for 3/4.

So, I'm out 100% New student is out 25%, bookstore is up 25% and C&T are up 100%.

How many new pages are in the 4th edition as compared to the 3rd?
Really, honest question--how many?

Actually new student will have the additonal 75% extracted when he goes to sell it because---the 5th edition will be out.

The distributional impact of fiscal policy is different than the distributional impact of monetary policy.

Cutting interest rates tends to increase asset prices. That might boost the economy but it does so in a way that helps people who own lots of stocks.

Short term stimulus programs that hand out cash to the poor through the unemployment system or SNAP also stimulate demand during downturns but those benefits tend to accrue more to the working class.

It's not surprising that The Right tends to favor a monetarist approach while The Left tends to favor of a Keynesian approach.

GDP isn't the only thing that matters.

"Increased spending and tax cuts have to be paid for". Must they ? This rejects Krugman's claim, as I understand it, that only debt service is required, not repayment of principle. Federal debt is generally denominated in sovereign currency, and so technical default is never necessary so long as printing presses exist. Inflation protected TIPS and nominal "obligations" for programs like government retirement, social security & medicare that will be expected to be inflation adjusted are more problematic.

The several problems with the Keynesian graphic above should be obvious to the causal cynic.

No one knows precisely when we are in a "boom". Like a market top, it's only clearly visible in the rear-view mirror. Many would argue that the recent <3% GDP growth, and still declining U-6 unemployment suggest we are not there yet, while others ....

A boom is in the eye of the beholder, the 'beholders' capable of enacting the policy suggested are all members of the Homo politicus, with very little genetic inheritance from Homo economicus. Further, Caplan has demonstrated that the voting public holds some strong, systematically wrong, biases wrt economic policy. IOW it's quite unlikely that sound ideas will convert grasshoppers into ants.

Studies, like Romer&Romer among many, strongly suggest that marginal government spending has considerably less economic impact (lower multiplier) than marginal private sector spending. Until these marginal rates of productivity equalize, a recession policy of consumption & income tax reduction should be better than than excess government spending policy. Similarly a "boom" policy of reductions in government spending should be preferred to increased taxation. In any case it's clear that centrally managing growth by government spending in the recession and extra taxation in the "boom" produces pessimal growth so long as private spending has a higher return than government spending.

I strongly suspect we are faced with a political reality that dictates policy trade-off between this classical Keynesian prescription for reducing GDP variation coupled with lower net GDP growth vs a less-managed GDP with more variation and higher net growth; the flatter but much longer path to the destination vs the bumpy & more direct path. Given the compounding effect of a lower growth rate, I expect the bumpy path is best, despite its downside.

Comments for this post are closed