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.

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.

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.

[I fixed this - by just going into and editing the comment. NG]

Im a bit surprised that you dont understand arguments that are essentially classical in nature.

‘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!

What people today call inflation is not inflation, i.e., the increase in the quantity of money and money substitutes, but the general rise in commodity prices and wage rates which is the inevitable consequence of inflation. This semantic innovation is by no means harmless.

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,

Inflation and credit expansion, the preferred methods of present day government openhandedness, do not add anything to the amount of resources available. They make some people more prosperous, but only to the extent that they make others poorer.

So to sum up

Evidently you think basic textbook macroeconomics is just an assemblage of Keynesian errors and deceptions

That is correct.

Im still damned if I know exactly which part of the analysis you dissent from and why

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.

Perhaps Jacques understands what youre saying, but I doubt it.

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 Says law, Ohio University Press (downloadable from the Mises Institute).
Steven Kates, 1998, Says Law and the Keynesian Revolution, Edward Elgar (very expensive – order from library).
Steven Horwitz, 2000, Microfoundations and macroeconomics: An Austrian perspective, Routledge (ditto).

Rather an expansion in the money supply (inflation) causes the illusion of excess demand.

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.

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.

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.

…paying more to keep good people in jobs is a sign of economic prosperity.

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.

In short, wed never see the excess demand in domestic product markets, …, that everyone else envisages would occur as a result of the increased consumer spending.

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.

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.

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 wed 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.

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? … and that the tax cuts are not financed by money creation …

Under 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”.

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.

Thank you, Brendan. You’ve made my day.

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.

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

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).

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

Let me give the other readers an example.

I have a paragraph

The idea that tax cuts could cause inflation is based on the notion of too much money chasing too few goods. Tax cuts, in this argument, inject money into the economy and consumers, who know no better, simply go on a spending rampage igniting inflation. At this point the Reserve Bank would have no choice but to raise interest rates and take back the tax cut. Any sensible government then should resist tax cuts. To those brought up on a diet of Keynesian economics, this story may even sound plausible. But this demand driven story completely ignores the supply side of the economy, as do all arguments not to cut taxes.

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 (“Im 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: “Says 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 doesnt make the citizens any poorer because the money all comes back to them when its spent. … The modern reader, who wont have entertained the fallacy in the first place, is unlikely to make much sense of the passage, especially when its 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!

BBB

BBB

The idea that tax cuts could cause inflation is based on the notion of too much money chasing too few goods. Tax cuts, in this argument, inject money into the economy and consumers, who know no better, simply go on a spending rampage igniting inflation.

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.

At this point the Reserve Bank would have no choice but to raise interest rates and take back the tax cut.

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.

Any sensible government then should resist tax cuts. To those brought up on a diet of Keynesian economics, this story may even sound plausible. But this demand driven story completely ignores the supply side of the economy, as do all arguments not to cut taxes.

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.

Last year Treasurer Peter Costello announced $14 billion of tax cuts over four years. Of that amount, $6 billion came into effect this financial year. The budget surplus this year will be $10 billion, with expected GDP at $1 trillion. Now we did hear the tax-cuts will lead to inflation argument last year. We were invited to believe that an injection of 0.6 percent of GDP would ignite inflation. The blunt reality is that our economy is not so finely tuned, nor so fiscally fragile, that a mere $6 billion or so would tip us over the inflationary edge.

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?

To the extent we saw inflation in 2006, it was due to bananas, oil prices, and the drought these factors are all short-term considerations.

Therefore….?

The federal government is running a budget surplus and the treasury is awash with money. This is despite the Howard government spending at an unprecedented level. So we need ask why it is that private expenditure leads to inflation, but not public expenditure?

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.

It is here that the Keynesian disdain for the humble consumer becomes apparent. Evidently consumers have a high propensity to consume, and worse a high propensity to import.

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?

The idea that people cannot be trusted with their own money is the worst sort of paternalism.

If you say so, but why does that mean that tax cuts aren’t inflationary?

A further and more important point to make is that tax cuts are not an injection into the economy. The money has already been earned by producing value-added goods and services. Tax cuts cannot crowd out private activity.

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.

Government spending can crowd out private spending, and government saving can crowd out private saving as the Treasurer has recently admitted

True! At full employment any new spending crowd out some other spending.

but tax cuts can never have an adverse impact on the economy while the government maintains a budget surplus.

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.

we arent debating the relative efficiency of private and public portfolio decisions

Actually 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.

In the run-up to the budget well be hearing a lot about the need for both prudence and increased government spending. Very often the same people will be making both arguments. With 2007 also being an election year, no doubt well see lots of spending initiatives in mid to late October. What well hear less of is the need for tax cuts. The argument against tax cuts has already been made; tax cuts will lead to inflation and interest rate rises. Of course, this argument is made every year. This is an argument designed to frighten children and the economically illiterate.

The idea that tax cuts could cause inflation is based on the notion of too much money chasing too few goods. Tax cuts, in this argument, inject money into the economy and consumers, who know no better, simply go on a spending rampage igniting inflation. At this point the Reserve Bank would have no choice but to raise interest rates and take back the tax cut. Any sensible government then should resist tax cuts. To those brought up on a diet of Keynesian economics, this story may even sound plausible. But this demand driven story completely ignores the supply side of the economy, as do all arguments not to cut taxes.

Last year Treasurer Peter Costello announced $14 billion of tax cuts over four years. Of that amount, $6 billion came into effect this financial year. The budget surplus this year will be $10 billion, with expected GDP at $1 trillion. Now we did hear the tax-cuts will lead to inflation argument last year. We were invited to believe that an injection of 0.6 percent of GDP would ignite inflation. The blunt reality is that our economy is not so finely tuned, nor so fiscally fragile, that a mere $6 billion or so would tip us over the inflationary edge. To the extent we saw inflation in 2006, it was due to bananas, oil prices, and the drought these factors are all short-term considerations.

The federal government is running a budget surplus and the treasury is awash with money. This is despite the Howard government spending at an unprecedented level. So we need ask why it is that private expenditure leads to inflation, but not public expenditure? It is here that the Keynesian disdain for the humble consumer becomes apparent. Evidently consumers have a high propensity to consume, and worse a high propensity to import. The idea that people cannot be trusted with their own money is the worst sort of paternalism. A further and more important point to make is that tax cuts are not an injection into the economy. The money has already been earned by producing value-added goods and services. Tax cuts cannot crowd out private activity. Government spending can crowd out private spending, and government saving can crowd out private saving as the Treasurer has recently admitted but tax cuts can never have an adverse impact on the economy while the government maintains a budget surplus.

Many good reasons remain why the government should cut taxes. As the Warburton-Hendy report into Australias taxes showed, the tax burden has increased dramatically since 1980. The government has provided some tax relief in the form of increased tax thresholds, but the top marginal personal tax rate has changed only once since 1990 last year from 47 percent to 45 percent. Despite the tax relief, the share of net income tax paid by the top 25 percent of income earners has increased from 60.4 percent in 1996/7 to 64.2 percent in 2003/4. Those Australians more likely to be entrepreneurial and innovative are being hard hit.

Economic theory is quite clear that high taxes impose high costs on the economy. Those costs are related to the marginal tax rate. In particular, those costs manifest themselves in lower work effort and lower private savings rates. Australia has experienced a long period of sustained economic growth. This past success, however, is no reason for complacency. Rather than spend public funds on white elephant projects and welfare churning the government should cut taxes and allow private spending to drive the economy forward. The idea that this could ignite inflation is simply wrong.