Why Stimulus Measures Don’t Work
I have an op-ed in today’s Age, highlighting the Ricardian and open economy macro arguments against using fiscal policy for demand management:
From the perspective of national saving, it makes no difference whether an increase in government spending comes out of the budget surplus or whether the government goes into deficit and borrows from capital markets. Either way, the government is saving less.
But this doesn’t mean that households will follow the government’s example. In fact, households are likely to save more in anticipation of a higher future tax burden due to the reduction in government saving…
Demand management is best left to the Reserve Bank and monetary policy, which has already responded aggressively to a slowing economy.
The sharp decline in the Australian dollar exchange rate is also a powerful stimulus to net exports, but any boost to demand from fiscal stimulus will also have the perverse effect of putting upward pressure on the exchange rate, reducing net exports. In an open economy, there is no free lunch from fiscal policy.
Fiscal policy still has a role to play in supporting economic growth, but it needs to focus on long-run structural and supply-side issues not short-term attempts at rigging aggregate demand.
This means rewarding labour force participation, not encouraging welfare dependence. Throwing more money at pensioners and families will not boost economic growth in the long-run and may not work as the government intends in the short-run.
In The Australian, Henry Ergas makes a similar argument against proposals to use superannuation contributions as a macroeconomic stabilisation instrument:
Consumption decisions are shaped not by transient changes in income but by expectations of income going forward, a proposition known as the permanent income hypothesis. A short-term reduction in compulsory savings, soon reversed and followed by a sequence of rapid increases in mandatory contributions, amounts to a pre-announced reduction in disposable incomes. As households respond to the news that their disposable incomes will fall once the temporary cut is reversed, consumption is likelier to decline than to increase.
My Age piece may have fallen victim to a which-hunt. This line should read:
‘The household saving ratio has already surged from 1.3% in the June quarter to 3.9% in the September quarter. This implies that taxpayers squirreled away their 1 July tax cuts, which came at the expense of the budget surplus rather than cuts to government spending. ‘
posted on 10 December 2008 by skirchner
in Economics, Fiscal Policy
(6) Comments | Permalink | Main
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Comments
In fact, households are likely to save more in anticipation of a higher future tax burden due to the reduction in government saving
LOL! Mate, the average punter does not give a moment’s thought to future tax burdens, and even less to the level of government saving. The punters are scared sh*tless they won’t have a job in six months time, that’s why they’re saving and paying down debts.
Really, you economists should get out more.
Having said that, I’m no fan of fiscal stimulus. Australia has Buckley’s chance of avoiding recession given what’s happening in China, so Kev should save his pennies for the avalanche of unemployed that’s heading to the nearest Centrelink in 2009.
Posted by .(JavaScript must be enabled to view this email address) on 12/13 at 04:29 PM
Even the Treasury argued that around one-third would be saved, which is consistent with the evidence cited in the op-ed.
Posted by skirchner on 12/15 at 12:53 PM
Even the Treasury argued that around one-third would be saved, which is consistent with the evidence cited in the op-ed.
I’ve got no disagreement with you that a lot of the fiscal stimulus will be saved, its why it will be saved that’s at issue.
Taxpayers do not share the Government’s magic pudding view of fiscal stimulus measures. The more the Government talks up its stimulus measures, the more likely it is that taxpayers will perceive the implications for their future tax burden and the less effective the stimulus will be
What utter nonsense. Here’s a list of reasons why Americans will be spending less this Christmas:
Will spend less due to inflation: 26%
Will spend less to save more: 20%
Will spend less due all the talk about the economy: 19%
Will spend less due to uncertainty about the future: 17%
Will spend less due to loss / risk of loss of jobs: 16%
Will spend less due to having trouble paying current bills: 15%
Funnily enough “anticipation of future tax burden” did not rate a mention.
Posted by .(JavaScript must be enabled to view this email address) on 12/16 at 05:19 PM
“Will spend less to save more: 20%
Will spend less due all the talk about the economy: 19%
Will spend less due to uncertainty about the future: 17%”
All of these responses could be consistent with expectations for a higher future tax burden.
Posted by skirchner on 12/16 at 07:34 PM
All of these responses could be consistent with expectations for a higher future tax burden
Mate what planet are you on? The last thing people are worried about at the moment is a “higher future tax burden” because the government might have spent too much. They’ll take all the largesse Kev is willing to spray around thank you very much.
People are worried about losing their jobs!
Seriously, go down to the nearest pub on Friday evening and talk to some real people.
Posted by .(JavaScript must be enabled to view this email address) on 12/16 at 10:07 PM
The sharp decline in the Australian dollar exchange rate is also a powerful stimulus to net exports
Looks like the AUD is heading higher again, which means the miners will be squeezed between falling prices, falling volumes and a higher exchange rate.
The news out of China, and east Asia generally, is simply awful.
Meanwhile, Bill Evans is forecasting that Australia will avoid a recession. What is he smoking?
Posted by .(JavaScript must be enabled to view this email address) on 12/18 at 08:37 AM