Tax cuts won’t do it

3 June, 2017 at 14:41 | Posted in Economics | 5 Comments

Stuck in the present ‘secular stagnation’ looking situation, politicians and economists have to make some choices if they want to get the economy going. From a Keynesian perspective one could perhaps contemplate

(A) central banks lowering interest rates and doing some quantitative easing

(B) governments cutting taxes and increase budget deficits (expansive monetary policies)

(C) governments expanding through spending of their own (expansive fiscal policies)

The first option is not a serious possibility when the economy is near the zero lower bound and the liquidity trap is slamming. Monetary policies run out of effectiveness in that situation. No injections what so ever that the central bank makes will generate the necessary inflationary impulses.

UnknownThe effectiveness of the second option hinges on people actually spending the money they get through tax reductions. Today, with seriously indebted households and firms, much of the money will simply be used to pay down debts. Although the effectiveness to quite a large extent depends on who gets the cuts and if the cuts are ‘hit and run’ or more permanent, interest rates and monetary policy actually matter little when we’re in a kind of balance sheet recession where many companies and households find themselves carrying excess debt that they have to pay down. The number of willing private borrowers are few – even when interest rates are at zero – and as a result of this a tax cutting monetary policy by itself has little expansionary force.

Increased liquidity will not not always and everywhere get us out of a recession. This seems to be something that even people like Greg Mankiw nowadays have come to realize. If we really want to get the economy going in the years to come, tax cuts will not be the magic bullet. Tax cuts are not delivering growth rates of 4-5 % or lowering unemployment rates to 2-3 %.

Tax cuts won’t do it. So we’re actually only left with the third option. The only way forward is to use expansionary fiscal policy. Unfortunately that takes courage and vision — something not exactly übersupplied with today’s ‘expansionary austerity’ politicians and central banks …



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  1. “(B) governments cutting taxes and increase budget deficits (expansive monetary policies)”. I’d classify cutting taxes and budget deficits as FISCAL policy. Typo?

    Re the idea that tax cuts may not be effective because of the large amount of household debt, I have doubts: if households are so keen to pay off their debts, why did they incur those debts in the first place? Put another way, a reasonable assumption is that households have the level of debt they want, and thus, given extra cash, they’d spend it.

    The rise in household debts is an entirely predictable reaction to the decline in interest rates over the last 20 years or so.

    Re the last para of the above article, I don’t accept that central bankers and politicians believe in Alesina’s absured “expansionary fiscal contraction” theory. However, they certainly haven’t grasped the point made by Keynes in the early 1930s (almost a century ago) namely that in a recession, the government of a country that issues its own currency can simply print money and spend it so as to escape a recession. Come to that, half the economics profession haven’t got that point either. Perhaps given another century or two they’ll get the point.

    In contrast, amateur economists seem to have got the point: in particular MMTers and Positive Money supporters.

    • “The rise in household debts is an entirely predictable reaction to the decline in interest rates over the last 20 years or so.”
      Perhaps you could share your reasoning.

    • Ralph – I disagree with your statement that people have the debt they “want”. Rather, I think they have the debt they feel compelled to take on in order to try to better their prospects, such as college debt, or to buy a house, as well as to provide a bit of comfort. In addition, the banksters will lend as much as, and more than, is prudent or necessary in order to suck up as much of a worker’s income as they can. Consider that banks control real estate prices by deciding how much to lend on any particular property.

      We are in a rapidly growing system of debt peonage (see Michael Hudson) and it looks like it’s not going to stop until it collapses of its own weight, taking millions of people down with it. It really comes down to the fact the debts that cannot be repaid, won’t be repaid. As that deadweight grows, the system becomes increasingly fragile.

      Some people, including me, are confident that another financial crisis is baked in; only the time frame and the known or unknown externalities are debatable.

  2. Very succinct and well said, Prof. Syll. Thank you.

  3. Bruce, I’m not the World’s expert on why interest rates have fallen, but presumably it’s because of an increased willingness by savers to save more. Certainly less developed countries have hoarded dollars (and to a lesser extent Euros, pounds, etc) and have been looking for some sort of return on those savings: e.g. the huge increased Chinese holding of US government debt. That has caused interest rates to fall, and when mortgagors find they can buy twice as much house for the same interest payment, obviously they’re tempted to do just that.

    John, I’ll concentrate on housing. In Germany and Switzerland where house prices have remained stable in real terms for the last 20 years, people are not borrowing more to “provide a bit of comfort” – unless you want to argue that Germans and Swiss 20 years ago were all paupers living in shanty towns – quite obviously not true. They borrowed more, and bought better houses because the fall in interest rates has enabled them to do just that. I don’t blame them.

    The UK is different. The UK failed to provide builders with enough land to build on, thus house prices in real terms have risen by over 200% in the last 20 years (see The Economist house price index for UK, German, etc house prices).

    Brits, like Germans, were not paupers 20 years ago. Brits have had to borrow more in order to maintain the same standard of comfort as they enjoyed 20 years ago. But they have not had to pay significantly more interest because of the fall in interest rates.

    Re irresponsible lending by banks, I agree that takes place. But that’s not a problem for mortgagors: if a bank wants to lend me money at an artificially low rate of interest, more fool them. If they go bust, I’m not bothered.

    Re your claim that “debts which can’t be repaid won’t be repaid”, that’s basically not an accurate description of how things have panned out the US in recent years. That is, there was obviously excessive debt at the start of the crisis, but those debts have been substantially paid down, the household debt to GDP ratio is now well below where it was at the start of the crisis – see link below. Doubtless that caused “debt deflation”, but it needn’t have done if Washington DC was not full of idiots (as Steve Keen suggests in the last para of his recent book “Can we avoid another financial crisis”). Also the fact that mortgages can’t be paid off doesn’t matter in the sense that in the South East of England, the majority of mortgages are “interest only”.

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