Riddle Me This, Economists
Posted by Jacques Chester on Friday, January 11, 2008
As a politician myself I have bitched long and loud about the naked cynicism that dominates policy creation in modern democracies. People vote for politicians making lovely-sounding promises, then act huffy and surprise when it turns out to be big fat fibs. Honestly, if you keep voting for liars and bad policy, what do you expect?
In any case, Mark Bahnisch of LP fame is musing — inter alia — that Kevin Rudd’s newly minted government should break its election-time tax promises. They are, according to Mark, “a waste of money”, which will “only fuel inflation”.
What I’d like to know from economists why a dollar spent by government is less inflationary than a dollar spent by the ordinary fellow.
My instinct is to be snide and clever, and to flourish this question rhetorically. But I would genuinely like to know the answer. Apart from problems of misallocation, sovereign risk, picking winners etc, is there a mechanism whereby taxing and spending is less inflationary than equivalent tax cuts?
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I guess the answer to that depends on what the money is spent on.
For example, a freeway that significantly reduces travel times from a warehouse to its outlets would reduce costs to business. If the total times reduced meant that the community saved more in costs than the cost of the freeway then there would be an overall reduction in inflation.
Similarly, if Government borrowed money for this at the bond rate, compared to private investors who want to have a return of 8%, there is also the possibility of a lower overall cost for that project. (I am ignoring financial engineering here - I believe that is a big con that will hurt a few people in the next months - but that is another story).
Finally, if the Govt spends money on infrastructure that then reduces costs to business, compare that to a proportion of private expenditure from say tax cuts which goes to buying 4WDs and plasma screens (ie consumption spending), you can see that there is a case for Govt expenditure on infrastructure being counter inflationary.
I am not saying that one is better than another, just that investment in infrastructure is likely to be less inflationary because there is a long term return on it that offsets its cost (and more if it is selected appropriately).
Posted on 11-Jan-08 at 5:26 pm | PermalinkMarks;
Good and well — but surely your argument overlooks the fact that tradies need to paid today for that freeway, thus driving up wages in an already competitive sector.
Posted on 11-Jan-08 at 5:32 pm | PermalinkRight, Jacques,
If there is a shortage of labour (as skilled as required), that can be conversely viewed as a surplus of money available to spend on building things. That is what we have right now across much of the economy.
In that sense money spent by government on building a freeway may be more inflationary than money spent by individuals buying LCD televisions - although the latter further contributes to the nation spending even more on imported goods than we earn from exports.
In the current state of the economy, the best thing is for neither to occur. Government should be running a large surplus and salting the proceeds away in things like the Future Fund.
Posted on 11-Jan-08 at 8:15 pm | PermalinkJacques, It is, in fact, slightly more inflationary for the government to take an extra dollar from the public and spend it than for the public to retain the dollar and spend it provided the public saves some of the dollar. Mark’s argument is just total nonsense - the money spent on infrastructure will contribute to aggregate demand just as extra private spending would. AS JC points out there is still the same pressure on resources and with a fully-employed economy the impulse will be inflationary in each case.
The government’s alternative is to run a bigger surplus and not spend the extra money. Much of this surplus would be generated by bracket creep so we are back to taxation by theft which I guess has the advantage for Mark of sounding like good Labor policy. In the long-run why should the government run surpluses and increase its tax take through inflation?
What is absolutely incredible in Mark’s remarks is the assertion that the evidence supports the notion that money spent by private individuals is ‘wasteful’. What evidence allows anyone to make such a normative judgement? Why should you prefer public over private expenditure on such grounds. Mark’s politics sound like they wandered out of the 1950s.
But I want the Rudd government to disappear quickly so I hope Mark’s solution is adopted. I hope too that in doing so that Rudd borrows ideas from Mark and tells the Australian publicd that the evidence shows their spending is ‘wasteful’.
Posted on 11-Jan-08 at 8:17 pm | PermalinkHm, so there we have so many bottlenecks in this economy due to poor infrastructure - iirc that nasty lefty Chris Corrigan remarked a couple of years ago on port infrastructure for one. We also have underinvested in our human infrastructure as well - try to get yourself a trades person for example. Try to see if you can hire an experience civil engineer for love or money. Are you seriously trying to tell me that this economy isn’t hitting capacity constraints in its infrastructure? If the private sector and the market was working you would think these capacity constraints wouldn’t happen.
I am not sure if my ideas are out of the fifties or not, but at least that is the NINETEEN fifties and not the EIGHTEEN fifties of poor infrastructure amid private wealth, where people lived in rich style financed by low tax, but had to ride through poor streets with garbage.
Mind you, the Australian public has woken up to the underinvestment in infrastructure by the previous government and is part of the reason the previous incompetents were run out of town.
Posted on 11-Jan-08 at 11:05 pm | Permalink“If the private sector and the market was working you would think these capacity constraints wouldn’t happen.”
Posted on 12-Jan-08 at 8:54 am | PermalinkAnd what sector of the economy fed false information to parents and kids for years about where their futures lay? They were all going to sit around pushing buttons while robots did all the work, well apart from all degrees needed to help make the community more aware. Yo yos and hula hoops educationalists, closed all the tech schools and pushed everyone through ‘comprehensive’ education and now what are we back to doing?
As for the funny money surplus, the best thing the govt could do with the cash is pulp it.
That’s a very deep comment observa. Perhaps you haven’t noticed where job growth has occured in the last decade (excluding WA), but you might want to check that out (or for that matter, starting salaries of graduates and the degrees they have) before slagging off having a degree. As for trades, you could also check the level of education that employers want before taking on people (hint: it isn’t year 9). Finally, can you give a suggestion for what all the people digging holes right now in WA intend to do once the boom is over, which I imagine isn’t too long hence?
Posted on 12-Jan-08 at 9:24 am | PermalinkThe dosh doesn’t have to be spent by government, Jacques, it could be saved.
Just sayin…
Posted on 12-Jan-08 at 11:34 am | PermalinkOr it could be paid into super accounts a la Keating, as I suggested in the original post.
A number of other suggestions (some rather clever, I think) about how the money could be directed into savings were made by LP commenters on an earlier thread:
http://larvatusprodeo.net/2008/01/09/fiscal-politics/#comments
Posted on 12-Jan-08 at 11:38 am | PermalinkIf it doesn’t have to be spent by government, wouldn’t it be better not taking it off people in the first place?
Posted on 12-Jan-08 at 12:41 pm | PermalinkAt the risk of offending everyone — hey, what the heck! — this whole thread is one of the weirdest I’ve read on this blog. Mark Bahnisch, following Richard Framer, was advocating that the government break its election promise and cancel the cut taxes. Jacques’s question, why government spending would be more inflationary than private, is not relevant, because no one is proposing that the tax cuts be spent on government projects. The proposal is to abandon the tax cuts and have a bigger surplus. Not one of the ten comments so far seems to have picked this up, including Harry, although his comment is otherwise sound.
For my part I agree with John Quiggin that Rudd should keep his promises, because restoring integrity to politics is more important than averting an interest rate rise or two.
Posted on 12-Jan-08 at 1:15 pm | Permalink‘that the tax cuts be spent on government projects’ should read: ‘that the money saved by abandoning the tax cuts should be spent on government projects’.
Posted on 12-Jan-08 at 1:17 pm | PermalinkFrom an economic perspective Labor the government should reconsider the tax cuts so as to allow the budgets “automatic stabilisers” to take effect.
The previous Liberal government barely used fiscal policy as an economic instrument, once the budget was back in surplus they considered that the job was done. The concept that the budget surplus should be 1% of GDP ensures that as the economy booms and tax revenue increases, so does government spending (and/or tax cuts), with an end result of increased inflation. By contrast, the much maligned Keating budgets peaked at surpluses of 1.7% & 1.8% of GDP in the 80’s boom years.
The budget surpluses of the last 5-6 years have been fuelled not by rises in output but by the rise of our terms of trade.
So, spending the windfall from a change in the terms of trade on income tax cuts is likely result in large budget deficits when global mining supply catches up with demand and our terms of trade drops.
There is a case for indexing tax rates but neither side of politics has proposed that (why would they when they get away with calling the return of bracket creep “reform”).
All that said, from a political perspective Labor would be mad not to deliver the tax cuts. The opposition can’t critise them for keeping them but the electorate will likely punish them for going down the core / non-core route.
The only thing that Labor can do is cut spending as much as possible, luckily they are in a good position thanks to the recklessness at the end of the Howard’s era.
Just how much Labor reduces spending (rather than redirect it) will show just what their true economic colours really are.
Posted on 12-Jan-08 at 1:31 pm | PermalinkI have seen both mooted, which is why I raised the matter.
Surpluses still need to go somewhere, don’t they? Is investing in shares less inflationary than building freeways? Is building freeways less inflationary than tax cuts?
I think my original question, generalised, would still stand.
Posted on 12-Jan-08 at 1:54 pm | PermalinkAre you serious, Jacques? If you are audacious enough suggest a ‘no’ answer to that question, then you have a radical idea indeed — one far more worth blogging about than the one you chose.
And you may have well have seen both mooted, but you chose to invoke Mark’s proposal, not the other one.
Posted on 12-Jan-08 at 3:00 pm | PermalinkI brought Mark’s up because it was there, it prompted my thinking, and it was convenient to link to.
Thinking about your questions and my question a bit more, I think I missed the point or underlying question: is fiscal policy a viable way to affect inflation?
As a fellow with Austrian sympathies I am inclined to say that it doesn’t matter where the government parks the money, inflation will manifest in some form or another, mainly because to Austrians inflation is simply an increase in the supply of money over the supply of goods & services.
If surpluses were to be parked in that case, I imagine the least inflationary move would be to buy into the MSCI world share index, rather than pouring billions into our own share market. If a future government busted open the future fund you’d see massive devaluation in the ASX. Contrariwise, selling out shares in the global economy wouldn’t make a blip.
Posted on 12-Jan-08 at 4:26 pm | PermalinkWhich with Jacques last point gets us to what could become the most important issue over the next decade- Sovereign wealth funds? SWFs are estimated to account for US$14 trillion by 2012 from about $3 trillion now.
Jacques, the Austrian school says that “surplus” is basically incubated inflation. The best thing we could do with it is to simply burn it and make sure the RBA doesn’t create excess money like that again. The other alternative is is to return the money to the rightful owners and have the central bank sweep out the excess money supply which would of course mean high interest rates. Having the goovernment spend the money would also mean the same thing.
Investing the money in the Morgan Stanley index is not the right thing to do if we consider that the effect is that it would cause asset price inflation elsewhere.
Posted on 12-Jan-08 at 10:39 pm | PermalinkJacques, go back and look at the post. You asked:
is there a mechanism whereby taxing and spending is less inflationary than equivalent tax cuts?
Surely you can see that this is an improperly framed question. There is simply no context in which it would ever be useful to compare the effects of ‘taxing and spending’ on the one hand with ‘cutting taxes’ on the other. You can compare the effects of spending with cutting taxes, as Harry did, or you can compare the effects of taxation versus debt or asset sales to finance a given flow of spending.
In any case it seems you are not really seeking guidance, but rather in reprising the asinine ‘Austrian’ argument that tax cuts at full employment aren’t inflationary.
Having done my best, twice in the last few months, to discover whether that argument has even a semblance of coherence, I don’t hold out much hope that a third attempt would yield any additional insight. So this time, I’ll just restate my conclusion: it’s a heap of utter crap, Jacques.
Posted on 13-Jan-08 at 10:05 am | PermalinkPossibly because the Gov. dollar was stolen or just plain non-existent so it is, by definition, not reality based.
Posted on 17-Jan-08 at 6:46 pm | PermalinkLike the entire inverted pyramid of the dismal science, none of them produce a wit of worth.
Well, that’s not quite fair. Galiani was a genuine wit. Marx, Veblen, Keynes and Galbraith all had their moments.
Posted on 17-Jan-08 at 8:47 pm | PermalinkJacques - read this.
Posted on 22-Jan-08 at 10:10 pm | PermalinkSinclair, I’d like to think that, if your aim is truly to help a bewildered layperson make sense of a current macro policy issue, you could do better than quote an arcane passage from an early 19th Century treatise, without a word of context or explanation. However, on past form, it’s clear enough that your aim is roughly the opposite, so I shouldn’t be surprised.
Say’s main objective in this and the preceding chapters of his book, is to refute the fallacy, commonly promoted by government apologists in his day, that taxation doesn’t make the citizens any poorer because the money all comes back to them when it’s spent. He is explaining that the net effect on the citizens depends on the utility to them of the government expenditure itself, as against the utility that would have been afforded through private consumption in the absence of govenment taxation and spending. The modern reader, who won’t have entertained the fallacy in the first place, is unlikely to make much sense of the passage, especially when it’s quoted out of context.
The second paragraph rests on Say’s distinction between productive and unproductive consumption; like Smith’s distinction between productive and unproductive labour, on which it is built, this belongs to the detritus of the process of forging our modern conceptual framework. These days we are able to distinguish usefully between consumption and investment, between physical and human capital, between goods and services, and between luxury and necessary consumption — but all of these distinctions were unhelpfully muddled together by the Classical Political Economists as a group.
All Say is really arguing here is the net effect of taxation that I referred to above will be negative, since governments tend to squander their revenue, whereas private households will spend theirs judiciously — either on efficient investment projects or on consumer items that they really want. This is a belief held by small-government advocates in general, which is hardly something we don’t already know, and, it has precisely zero bearing on the macroeconomic issues that Jacques raised.
Posted on 23-Jan-08 at 11:09 am | PermalinkAs always, James I find your comments incoherent - as you do mine. I am under impression, for example, that politicians still argue that taxation is good because the money comes back to the community. Indeed, your good self has argued that taxation can, and should be used to combat inflation. My understanding of Jacques question is
Answer: It isn’t. But wait, there’s more. Government spending is associated with a deadweight loss of taxation or inflation due to money creation. Even worse, government tends to invest in zero (or negative) net present value projects so waste even more money. The latter point isn’t as bad as it seems, because people choose through the political process to do so, yet it remains either a zero or negative NPV.
Finally, how can my quote be out of context? I have provided a link to the whole book and specifically to the whole chapter. (I do disagree with the argument that taxes be progressive, but the rest of Say is all very good).
Posted on 23-Jan-08 at 11:28 am | PermalinkSinclair;
In James’s defence, he has been drawing a distinction between tax-and-spend and tax-and-hold policies when arguing this issue.
Posted on 23-Jan-08 at 12:28 pm | PermalinkTax and hold what? The government holding a portfolio of financial assets to park the money is a zero NPV project before deadweight losses - taxpayers could invest their own money in their own prefered investment vechicles. For the same reason firms shouldn’t hold too much cash, so too government should hold too much cash either. The next question is what happen next? Even if we believe that government can fine-tune with fiscal policy what happens when they decide to cash out? If they spend the money all we’ve had is past government subsidising future government spending.
Posted on 23-Jan-08 at 12:44 pm | PermalinkSinclair
The fallacy that Say is refuting is not that governments provide goods and services to compensate for the loss of disposable income due to tax, but that the lost income is restored as income when it pays for those goods and services. And yes, some politicians may say things that like that, but only somebody who was deeply confused would take it seriously.
The correct answer to Jacques’ question is this: It isn’t. And no one is saying that it is. What they are saying is that a dollar retained by the ordinary fellow to spend at his discretion is less inflationary than a dollar he surrenders as tax and is withheld from the flow spending. If the government spends the taxed dollar, that will be slightly more inflationary, for the reason Harry explained.
Whether government investment projects have a positive or negative NPV tells us nothing about the short-term inflationary impact of public spending. It doesn’t tell us much about future productive capacity and long-term inflationary pressures either, unless we know how much, if any, private capital accumulation is crowded out by the government investment.
Posted on 23-Jan-08 at 12:47 pm | PermalinkYes, I agree. Unless government spending causes the money supply to expand it should not cause inflation at all. But I argue that government spending is less valuable than pollies often argue and so should be limited - over and above any considerations like inflation etc. I also work on the presumption that government spending does crowd out private spending.
Posted on 23-Jan-08 at 1:13 pm | PermalinkSinclair,
I hadn’t seen your #25 when I last commented. You refer to the fact that
‘..taxpayers could invest their own money in their own preferred investment vechicles.’
But we aren’t debating the relative efficiency of private and public portfolio decisions. As Jacques said, we are talking about the effect on inflation of cutting taxes versus not cutting taxes, for a given level of discretionary government spending. The beneficiaries of the tax cuts might save some of the money, but they are going spend much, if not most, of it on consumer goods and services. (I take it that you don’t subscribe to the Ricardian Equivalence Hypothesis — if you do, you could have saved us all a lot of time and confusion by mentioning this earlier.)
So, could we please clear this up. Do you deny that a substantial reduction in income tax, not accompanied by a reduction in discretionary spending, is likely to increase the inflation rate?
To clarify: I assume the economy is operating at full employment, and that the tax cuts are not financed by money creation (normally I wouldn’t consider it necessary to make this assumption explicit, but since you keep mentioning the case of monetary financing, I guess I’d better). Finally, I assume we are living under the current monetary regime, where the central bank does not attempt to control M3 or any similar monetary aggregate.
Posted on 23-Jan-08 at 10:21 pm | PermalinkActually that is precisely what we are debating. You seem to imply that public decisions can be better than private decisions and I suggest the opposite.
Rather than rehash things I’m posting an op-ed from the Fin Review from last year. “Tax cuts best fuel to drive the economy” The Australian Financial Review, February 22, 2007, pg. 63.
Posted on 24-Jan-08 at 10:12 am | PermalinkSorry, Sinclair, but you haven’t even begun to make a convincing case here. For all its faults, your October piece with Alex at least pretended to make some theoretical arguments.
So far there is no argument, just a foretaste of your later (irrelevant) contention that taxation is patronising. Unless you have some basis for believing that households do ‘know better’, then there is nothing of substance to take up here.
That’s a silly characterization. Higher interest rates don’t ‘take back’ anything. They discourage spending by firms and households expenditures by making it more expensive to borrow.
What nonsense. The ’supply side’ is in fact central to the story, i.e. there isn’t enough productive capacity to meet the extra demand that the tax cuts would stimulate. If anybody is ignoring the supply side, it’s you.
So you’ve abandoned the theortetical argument tax cuts don’t stimulate demand. (Actually that argument didn’t even get off the ground, but with a bit of luck, the reader won’t have noticed.) We are now just quibbling about magnitudes: you’re saying that the tax cuts won’t cause inflation in practice, because they’re very small. I wonder if this still applies, given the government’s election commitments. How large a tax cut would be inflationary?
Therefore….?
Here we go again. The issue is tax cuts versus no tax cuts, not tax cuts versus more government spending. Of course an increase in public expenditure would be inflationary.
What’s with the ‘evidently’? Either you accept the econometric evidence or you don’t. And even if ‘Keynesians’ (whatever you mean by that term) are disdainful, how does that bear in any way on the question whether extra demand is inflationary?
If you say so, but why does that mean that tax cuts aren’t inflationary?
This is a brazen non sequitur, if ever I saw one. How the purchasing power was obtained is completely irrelevant to whether spending it causes inflation.
True! At full employment any new spending crowd out some other spending.
This is just a restatement of your previous unsubstantiated assertions. And why is the sign of the budget balance relevant?
The remaining two paragraphs are microeconomic arguments. Yes, we know you favour minimal government on efficiency and moral grounds. But that’s not what this particular discussion is about.
Posted on 24-Jan-08 at 4:32 pm | PermalinkSerious question James: what type of tax cut would you make if your sole purpose was to expand the productive capacity of the private sector?
BBB
Posted on 24-Jan-08 at 4:46 pm | PermalinkTell me how that’s relevant to the inflation question, BBB, and I’ll answer with pleasure. If there’s one thing you would have grasped from my above comments, it’s that I’m sick of red herrings.
Posted on 24-Jan-08 at 4:55 pm | PermalinkNo idea how it is relevant to inflation, James. It wasn’t a trick question or anything. I just want to know what the standard economist’s response would be to the question: in the Australian context, what is the best kind of tax cut if increasing the productive capacity of the private sector is your goal?
BBB
Posted on 24-Jan-08 at 5:58 pm | PermalinkJames, you seem to suffer from the misapprehension that I’m trying to convince you of something. I long ago took the view that you are unconvincable of anything, other your own prejudices. The bottom line is that your fisking of this piece, and the other, is such a distortion of what I have said that I can’t be bothered to respond in detail.
Let me give the other readers an example.
I have a paragraph
In this paragragh I set out a caricature of an argument (I then go on to suggest the notion of these tax cuts being a lot of money is incorrect). In the fisking, James somehow manages to pass this off as being my argument, and critiques it as if these are my views. I view this as being fundamentally dishonest - I know James is not stupid. So now why should I bother engage in any discussion? While students’ have to tolerate this sort of (attempted) intellectual bullying and dishonesty (”I’m sick of red herrings” - puh-leeze, so sorry for having a different opinion o’ great and mighty philosopher) I really don’t see why I, or anybody else intellent, should.
Lest anyone think I’m being too harsh, let me give another example:
James: “Say’s main objective in this and the preceding chapters of his book, is to refute the fallacy, commonly promoted by government apologists in his day, that taxation doesn’t make the citizens any poorer because the money all comes back to them when it’s spent. … The modern reader, who won’t have entertained the fallacy in the first place, is unlikely to make much sense of the passage, especially when it’s quoted out of context.”
Sinclair: “I am under impression, for example, that politicians still argue that taxation is good because the money comes back to the community.”
James: “And yes, some politicians may say things that like that, but only somebody who was deeply confused would take it seriously.”
Those “deeply confused” people would be the electorate!
Posted on 24-Jan-08 at 6:12 pm | PermalinkSinkers isn’t trying.
The previous Government interfered with the automatic stabilisers.
We should have had a surplus of 2-3% of GDP but settled for something much less moreover they increased the structural deficit.
This does cause problems with demand when it is already too strong and given the 16 years of continuous growth we have no spare capacity.
Howard and Costello could have had tax cuts until the cows came home IF they commensurately cut spending instead they increased it.
Unfortunately Neither Swanny nor the Ruddster will cut spending sufficiently and so will have a surplus which is too small
Posted on 24-Jan-08 at 7:16 pm | PermalinkJames, it is not your logic that riles me, but the dishonesty of the status quo that burns me up. It is an interesting argument to use fiscal policy to attack inflation caused by monetary policy, which is essentially what you’re advocating when you state that it is tax cuts that cause inflation. Budget surpluses without tax cuts hides some of the effects of an overly expansive monetary policy by essentially ring fencing the over-supply of money through tax and NOT spend. This is a dishonest approach, even if it is technically correct that tax cuts would lead to exposing the inflation inherently caused by the RBA. It is the treachery of such government and central bank policy that I abhor and reveals some of the flaws of the central banking system.
Posted on 24-Jan-08 at 7:26 pm | PermalinkHomer, I’m sure James thinks I’m very trying
We all agree government should cut spending.
You can’t know for sure that we do have a structural deficit - Treasury forecasts have been very conservative and over the past 11 years the under-estimate has been (approx) $75 billion. If that money had been paid as tax cuts the top marginal rate could have been 30% and the capital gains eliminated in toto (on revenue grounds, there may be other reasons to keep a CGT - not that I think so).
Posted on 24-Jan-08 at 7:30 pm | PermalinkBrendan,
you ain’t using fiscal policy to anything apart from letting it do its job.
That is what automatic stabilisers are for.
As Kruggers would say you only use fiscal policy as a last resort because you have to , usually in a depression otherwise use monetary policy.
In this case Howard and Costello were into expansionary fiscal policy when the RBA was tightening.
Very silly
Posted on 24-Jan-08 at 7:52 pm | PermalinkSinclair
No one who has been following the discussion could think that I would mistake the position you are repudiating for the one you are advocating. In any case, it’s obvious you are ridiculing that position, isn’t it? As for deliberately misleading them what on earth would be my motive?
Someone who hadn’t been paying attention might have confused when I wrote ‘So far there is no argument…’. It would have been much better if I had said ‘counterargument’. However, I then note that the thrust of your critique is that the view you’ve summarised is patronising. This wouldn’t make much sense if it was your own. And after the next section I accuse you of offering a ’silly characterisation’ — that is, a distorted and unhelpful representation of the position you intend to attack.
As far as Say is concerned, I don’t know what your grievance is. To understand the first of the two paragraphs you quoted, one needs to be aware that he’s countering a residual mercantilist argument that no one would make today, except someone who was very naive and confused. This is the argument that taxation takes nothing away from households because they get the money back when the government buys services from those same households. This is not to be confused with the argument, which defenders of government obviously do make, that the government makes up for the confiscated income by providing goods and service to the households. I did try to clarify this at #26, but evidently I failed.
I stand by the red herring complaint. Your arguments have mostly been about the efficiency and morality of governments’ practice of taxing the public and spending the money on their behalf.
In an effort to get to the bottom of the thing, I asked you a very specific, carefully framed, question at #28. I don’t regard your AFR column as having answered that question. If you think it’s not worth the effort to convince someone as prejudiced as me, that’s understandable. But I doubt you’ve convinced any open minded readers either. I’d be interested to hear from them.
Posted on 24-Jan-08 at 9:45 pm | PermalinkBBB, it depends on where the bottlenecks are. If it’s unskilled or semi-skilled labour, the high effective marginal tax rates on dependent spouses would be a suitable target. If it’s skilled labour, perhaps we could keep more such workers at home by flattening the income tax schedule further, but I don’t know what the emprical evidence is on emigration and income. More university scholarships would help too. If the problem is antiquated physical capital, the usual solutions are to reduce profit tax and offer accelerated depreciation to encourage investment.
Posted on 24-Jan-08 at 9:59 pm | Permalink…it is technically correct that tax cuts would lead to exposing the inflation inherently caused by the RBA.
Thank you, Brendan. You’ve made my day.
Posted on 24-Jan-08 at 10:52 pm | PermalinkJames,
Would you not agree though that using taxation to ring fence inflation is bad policy? Why not have a more responsible monetary policy? I’d be interested in escaping this endless discussion of tax cuts and inflation and discuss alternate policies to prevent fiscal policy from being an adhoc way of preventing inflation. Even a modest proposal of targetting monetary to supply to maintain price stability against a basket of commodities would be more useful than pursing price stability against consumer goods & services.
Posted on 25-Jan-08 at 12:20 am | PermalinkUnder the hypothetical conditions you describe, I would expect that some of the tax cut would be saved and some would be spent. I would also expect that imports would increase, and that to the extent there was any price changes (not inflation) it would occur via the exchange rate - alternativily we’d see a change in the current account.
Depending on what you mean by full employment, other things may or may not happen. I tend to take the view that given institutional constraints the economy tends to be at full employment most of the time. So tax cuts may still have incentive effects in my vision of ‘full employment’ but may not in your vision of ‘full employment’.
So generally - in the absence of any other information - my answer to your question is “Yes”.
Posted on 25-Jan-08 at 6:11 am | PermalinkUnder the hypothetical conditions you describe, I would expect that some of the tax cut would be saved and some would be spent. I would also expect that imports would increase..
We agree on that much, to my relief. But the rest is not too clear. My best guess at your meaning is that the proportion of total spending directed to imports would need to increase, that this would require a real exchange rate appreciation, and that the real exchange rate appreciation would occur seamlessly by means of a nominal appreciation rather than through a rise in the domestic price level. (Presumably this would reduce exports as well). In short, we’d never see the excess demand in domestic product markets, the labour shortages, and the wage pressure, that everyone else envisages would occur as a result of the increased consumer spending.
If that is indeed what you’re saying, I don’t know what you mean by ‘alternatively we’d see a change in the current account.’ If the additional consumption is crowding out net exports, that would obviously imply a current account deterioration, so why is the latter an ‘alternative’?
Setting that aside — perhaps you wrote in haste — I don’t agree with you. The only mechanism that would cause the nominal exchange rate to appreciate as required would be expectations of a higher interest rate. But, to use your own words, the economy is not that finely tuned. Nominal exchange rates never jump in a predictable fashion. On the contrary, domestic price inflation is the normal way in which a real appreciation occurs in the face of domestic excesss demand.
Nevertheless, I’m pleased that we have isolated the point of disagreement, and it seems we share the same frame of reference after all. I can stop worrying about how the immorality of taxation and the inefficiency of government fit into the story.
Posted on 25-Jan-08 at 10:22 pm | Permalink‘I’d be interested in escaping this endless discussion of tax cuts and inflation…’
You started it, Brendan, and kept it going. But since you seem to have conceded on the main issue, I’m happy to change the topic.
My general position on the role of fiscal policy in managing aggregate demand is much the same as the one that Fred Argy put in his last two posts. I think there is a role for governments in stabilising aggregate demand, and two instruments is better than one.
If you agree that the budget should be balanced over the cycle, you have to accept that there will be surpluses some of the time. As Sinclair pointed out, however, it starts getting difficult to rationalise big surpluses after twelve years of them. But it’s better to wait for a slow-down rather than cut taxes when the economy is running hot. (Who knows — maybe we’re about to get our chance.) Actually, I already made all these points in our previous discussion, as you may recall.
Posted on 25-Jan-08 at 10:45 pm | PermalinkWithout any knowledge of what else is happening in the world we can’t be sure what would happen to the exchange rate.
There is a causality issue here. My view is that excess demand does not lead to inflation. Rather an expansion in the money supply (inflation) causes the illusion of excess demand.
“the labour shortages, and the wage pressure” are what happens when the economy grows rapidly. People carry on as if this were ‘a bad thing’. Economic growth is not a bad thing - paying more to keep good people in jobs is a sign of economic prosperity. To my mind this is always preferable to the alternative. No labour shortages implies high unemployment - now at the institutional level this may be voluntary unemployment, but the individual level this may well be involuntary unemployment. Stagnant wages are also not a sign of a prosperious economy.
Posted on 26-Jan-08 at 10:03 am | PermalinkSinclair, when you write
do you actually mean to define inflation as growth of the money supply? That must cause a lot of miscommunication.
Anyway, what I’m talking about is a rise in the general price level, whether you call that inflation or not. And a rise in the general price level is what you’re going to get when the economy is at full employment and there’s a sudden increase in consumption spending (which you’ve agreed will occur). The only thing that would prevent the price rises happening, would be an offsetting fall in some other department of spending: either a fall in net exports, via the miraculous exchange rate appreciation you postulated at #43; or in investment, via a preemptive, and unprecedentedly effective, monetary contraction.
It depends entirely on whether the growth is sustainable. Spending can’t grow faster than productive capacity if the two are already more or less balanced. And it’s precisely that balance that is disturbed by a policy-induced increase in consumption.
Yes, generally speaking, real wages move pro-cyclically, as we know. That is, they rise as the economy moves from stagnation and high unemployment, to high growth and very low unemployment. But once we’ve reached full employment, then by definition we’re at the limit of what firms can pay workers before they need to raise their product prices to cover the wage bill. The fiercer the competition for labour, the more likely this is to happen.
All of this seems to me, and presumably just about anyone else reading this, the most basic textbook macroeconomics. Evidently you think basic textbook macroeconomics is just an assemblage of Keynesian errors and deceptions, but, having read two of your op-ed pieces and all your comments on this thread, I’m still damned if I know exactly which part of the analysis you dissent from and why.
Perhaps Jacques understands what you’re saying, but I doubt it.
Posted on 26-Jan-08 at 10:25 pm | PermalinkYes, I understand that any (upward) change in the CPI is generally called inflation. I think that is a problem because I’m convinced by Mises’ comment
Similarly Arthur Seldon defines inflation as ‘a fall in the value of money due to a persistent expansion in its quantity’. But you’re on reasonable ground, Milton Friedman, for example, has said, ‘By inflation, I shall mean a steady and sustained rise in prices’. Friedman goes on to claim that increases in the stock of money cause inflation. To be clear, Friedman argues, ‘more rapid increase in the quantity of money than in the quantity of goods and services available for purchase will produce inflation, raising prices in terms of that money’. So Seldon, von Mises and Friedman agree that a general sustained increase in the average price level is caused by an increase in the quantity of money. Friedman, however, chooses to define inflation by the symptom, while Seldon and von Mises define inflation by its cause.
Quoting Mises again,
So to sum up
That is correct.
You’re not trying hard enough
I understand your perspective perfectly. As you say it the standard macroeconomic position. I’m a bit surprised that you don’t understand arguments that are essentially classical in nature.
At this point, I agree. But Jacques is a clever boy (hi Jacques) and at some point will allocate his reading time to people like Smith, Mill, Mises, Hayek and if he wants to further explore the issues I have raised here
W. H. Hutt, 1974, A rehabilitation of Say’s law, Ohio University Press (downloadable from the Mises Institute).
Posted on 27-Jan-08 at 12:17 pm | PermalinkSteven Kates, 1998, Say’s Law and the Keynesian Revolution, Edward Elgar (very expensive - order from library).
Steven Horwitz, 2000, Microfoundations and macroeconomics: An Austrian perspective, Routledge (ditto).
‘Classical’ in the context of macro theory is usually a short hand for infinite-horizon optimising models with perfect foresight or well-behaved stochastic processes and rational expectations. The result that drops out of such models is the Ricardian Equivalence Hypothesis, but since you’ve explicitly
agreed that consumption would increase, obviously that isn’t what you have in mind. As I understand it, ‘Austrians’ are against mathematical equilibrium models anyway.
On the other hand, if you mean Classical Political Economy, I reckon I have a pretty fair knowledge of the field. I’m not aware of any discussion of this exact issue in the Classical canon, but presumably most of that group would have said that tax cuts would increase the need for government borrowing and thereby divert savings from productive investment. You could have ventured a similar argument, but as far as I can recall, you didn’t do so in either of the articles or in any of the comments. I wouldn’t have been convinced by such an argument — not in the context of a 21st Century economy with integrated capital markets — but at least I would known where you were coming from.
I do share your hope that Jacques will at some stage consult this literature (assuming he has already completed at least an introductory principles course — otherwise it will be very hard). But he’ll be disappointed if he’s seeking support there for ‘Austrian’ dogmas, especially as they relate to macroeconomics. He’ll search in vain for any coherent short run macro or monetary theory in Smith. J.B.Say and Mill Sr. were primarily interested in refuting mercantilist, physiocratic and naive underconsumptionist notions of their day, and had very little feel for the implications of the switch to a credit money system. Ricardo’s monetary doctrine is the closest to what you are characterising as ‘classical arguments’, and is generally considered a backward step from Thortnton’s, which was much more penetrating. Mill Jr. has the definitive classical discussion of Say’s Law, but Jacques won’t find any support for there for the a simplistic dichotomy between the price system and the real economy that you espouse.
Speaking of Say’s Law, I note that your contemporary reading list all relates to that doctrine. This seems to imply that your denial that tax cuts cause inflation is somehow a corollary of the defense of Say’s Law presented in those books. Even if that was true, and I don’t understand your argument well enough to judge whether it is, I’m not, in any case, at all impressed by Hutt and Kates. I agree with Mark Blaug that neither of the two seems to have noticed that the principal causes of unemployment in mature capitalism are different from the causes in developing countries (including France and Britain at the time of Say and Ricardo). In short, I think anyone who denies that market economies are prone to periodic crises of confidence and insufficient aggregate spending is just being ridiculous.
Finally, Mises’ complaint about the changing definition of inflation being ‘by no means harmless’ is comical but understandable. It makes it much easier to argue that inflation is caused only by increases in the money supply if you define inflation as price increases that are caused by increases in the money supply!
Posted on 27-Jan-08 at 4:12 pm | PermalinkSorry, I forgot to put blockquote tags around the first line.
[I fixed this - by just going into and editing the comment. NG]
Posted on 27-Jan-08 at 4:17 pm | PermalinkJS Mill does have the definitive classical argument for Say - but I far prefer Schumpeter’s treatment in his History. Rothbard too has a better explanation than does Mill - just my opinion.
Anybody can (and should) read Smith and Mill - even without having done Principles of Economics. Only three of the seven authors can be described as being ‘Austrian’ and it is possible to appreciate Mises and Hayek without being Austrian per se.
Posted on 27-Jan-08 at 10:26 pm | PermalinkJames,
My statement that “…it is technically correct that tax cuts would lead to exposing the inflation inherently caused by the RBA.” may sound like a concession, but it is consistent with the principle that inflation is and always will be a monetary phenomenon. Unspent surpluses aren’t controlling demand, they are controlling the supply of money. It is an inefficient and haphazard way of influencing the money supply.
I could make a similar argument for controlling inflation by reducing welfare payments. Less income going to welfare recipients who are most likely to spend it would put downward pressure on consumer prices. So let’s make a case for reducing the welfare budget on the basis of controlling inflation!
Or better yet, we could develop a monetary policy that actually targets money supply.
Posted on 28-Jan-08 at 9:40 pm | PermalinkUnspent surpluses aren’t controlling demand, they are controlling the supply of money.
It’s clear from this that you really don’t know what you’re talking about, Brendan. I’m afraid my patience has run out.
Posted on 28-Jan-08 at 11:13 pm | Permalink