It has been some time since I wrote my last article for Nolan Chart.
However, one of my few articles, Taxes and their Effects on the Economy laid out a controversy many economists, from Paul Krugman to Gary Becker, agree on.
Both New Classical and neo-Keynesian economists understand the potential for a lack of positive effects by taxes. When individuals intuit their long run consumption patterns, it turns out they adjust their intertemporal consumption schemes to expected government spending shocks, especially when it's borrowed money.
This is why Paul Krugman would argue that government spending would almost certainly, in this case, have larger multiplier effects on the economy. Gregory Mankiw still believes in the possibility for a larger tax multiplier effect, but this assumes that there is no substantial degree of expectations for deficit financed government spending. The expectations for government borrowing against the future might be rather high causing people to save rather than spend.
The debate becomes more interesting once we include the New Classical point of view on macroeconomic activity. Suppose people were to save their tax cuts. This means that credit floods a credit strained market causing a reduction in the rental rate of capital for firms willing to expand. But, if the government continues to borrow for its massive deficit financed stimulus, it can severely crowd out investment, even in a financial system where credit supply is rather low.
Allow me to admit that one can easily argue that government can make better decisions, in a time of market failures, to allocate resources to the right sectors - thus maximizing government spending multipliers. This would be great for an economy that requires a little boost. To most economists, this argument doesn't fly so easily since past stimulus plans reveal inefficient uses of resources. In other words, the multipliers were way overestimated and could've been put to better use by the market.
Thus far, it would seem that the best move is to cut taxes, with no deficit spending, since saving can stimulate more investment. But a new problem has arisen. Despite the fact that people in these times are more in tune to save, it doesn't mean that will positively affect the interest rate in the "supply of loanable funds" and thus the investment side of GDP.
Although it wasn't necessarily non-optimal or irrational behavior in risky investments that led to the current crisis, sudden costly shocks in the economy tend to significantly alter consumer preferences and profit maximizing behavior for firms. As a result, very tight risk aversion has become common amongst savers and financial intermediaries, explaining falling nominal interest rates but rising real interest rates. Regardless of how much incentive the Fed has tried to provide to stimulate the credit market through the Fed Funds Rate, and a variety of other old and new monetary policy tools, there has been no significant positive change in lending behavior amongst financial intermediaries.
There is currently very inelastic behavior in the loanable funds market, and much less risky financial instruments being financed by the private market. This is obviously the reason why the Fed has taken up the "slack" by the private market to provide capital for investment. All of this can be easily explained by the alterations in risk preferences by lenders.
©2009 Jeff Peters, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Thursday, January 15, 2009
Last modified: Friday, March 6, 2009
The views expressed in this article are those of Jeff Peters only and do not represent the views of Nolan Chart, LLC or its affiliates. Jeff Peters is solely responsible for the contents of this article and is not an employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
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Reader Comments:
Posted By: Walt Thiessen
Date: 2009-01-15 05:57:49
Did you ever stop to wonder why a fiat-money-based economic system requires stimuluses? Only an unstable monetary system requires stimulus. Stable monetary systems require no stimuluses at all.
Posted By: Christopher Espinal
Date: 2009-01-15 08:37:03
From my reasoning I find that to be a faulty point of view, unless I'm missing out on some important variable. To say that only unstable fiat monetary systems are what require stimulus is to reject the notion that there exist economic downturns in the real economy. By real economy, I mean having an economy where all values in GDP are expressed with respect to real goods (not dollar bills). One can argue that downturns ultimately originate from the real side of the economy. I know the Austrian School rejects that perspective (since they deductively observe real impacts from inflationary policy) - but I need more education to understand which is correct or has better predictions.
At the end of the day, these packages are aimed at improving the real economy. This is an very controversial area of macroeconomics.
Posted By: gene
Date: 2009-01-15 10:12:19
Hi Chris, good article! I have always had a problem when economists or politicians claim a "multiplyer" effect. You can only multiply anything by entering something else that isn't already there. so, it has to be either new printed money, or new borrowed money that is the actual multiplyer. Borrowed money must be paid back by the taxpayer, I would think at some point and printed money only serves the purpose of making money less valuable which is a wash at best. So the real question would be, is there real underlying value being created that reflects growth of value beyond the increased debt or newly minted money? An analogy would be the current housing bust, many people created "value" by using the supposed equity value they had obtained from the rising prices of their houses. What they withdrew with equity mortgages is virtually the same as printed money or debt. So now that prices have declined does the value that was created still exist? Another question, houses that were built that lie empty, does their value exist? If an individual has 5% equity in a house whose mortgage was made possible by "fiat" policies[at least whatever percentage was made possible} who actually has the equity and how does that effect actual value?
Posted By: Master C
Date: 2009-01-15 11:34:34
Ha! Ha! Ha! I think Walt got a little lesson in the EXTREMISM and SINGULARITY of his views from someone other than me! To recognize OTHER factors that can cause a downturn in the economy ~ demand decay, poor product selection, labor unrest, war spending, weather conditions, a preference for foreign products, product fears, severe unemployment, exchange rate disadvantages... ~ is to BROADEN your understanding of MODERN markets.
The OLD DAYS have passed us by. Only those who understand how essential the FIAT system is to GLOBAL economies will be able to survive in them.
Master C
Posted By: Jahfre Fire Eater
Date: 2009-01-15 12:57:03
Hi Christopher,
Nice article.
I cringe when I see a reference to Krugman other than to heap derision upon him. He is an academic hero and a government lackey both for the same reason: because he rises to the task of being an eternal apologist for the inevitable discrepancies between the theories he espouses and that which the rest of us call reality.
Yes, you're right that, "one can easily argue that government can make better decisions, in a time of market failures, to allocate resources to the right sectors - thus maximizing government spending multipliers." Marxists and progressives of every strip have been easily making that ridiculous argument forever.
The predictive power of Austrian economics has debunked that easy argument for nearly just as long. Only those with a vested interest in ignoring how the real world compares to their theory can still support such nonsense...like Krugman. How could one possibly advocate rampant government spending unless also holding with the notion that the government would make good choices about where it is spent?
There is one way. If one doesn't think it matters where the money is spent, as long as it is spent fast. Is the basis for Krugman's support of Obama-nomics? I don't think so. There really isn't any need for government to be involved at all if this were the rationale. Bernanke could just start dumping dollars into everyone's checking accounts electronically if it didn't matter where it was spent.
So, since history has shown over and over and over that the flaw in central planning is the impossible problem of information, Krugman's premise that the government will make wise spending decisions is patently false...but what else could we expect from the druid-like academic guru who earns power and respect by encouraging politicians to corrupt our future. He knows who butters his bread and it ain't anyone of us.
The only way out of a recession is to increase production.Obama-nomics aims to mime the activities that look productive. We are not a cargo cult tribe for crying out loud. We should be able to recognize the difference between productivity and subsidized actions that simulate productivity...but obviously no one in Washington can, or has the incentive to try. Our culture has trained them to substitute the symbolic for the real with no discrimination.
Change the incentives, change the behavior. That is the only solution to our cultural decay and the dumbing down that has brought us to this economic collapse.
-Jahfre Fire Eater
Posted By: daddysteve
Date: 2009-01-15 16:53:38
Big government has worked so well that, obviously, bi gger government will work better.