NY Fed research report- a payroll tax holiday will make the economy worse
Posted by WARREN MOSLER on November 13th, 2009
Just read through it quickly.
Assumptions:
First, they use a full Ricardian assumption- lower taxes now ‘price in’ the higher taxes later to keep the budget balanced long term
Second, because real rates go up as nominal rates hit zero expectations are for lower prices and therefore spending goes down.
Third, as real wages go up with payroll tax cuts, the desire to work is assumed to go higher, putting downward pressure on wages and costs, reducing prices on the supply side, also raising real rates as the nominal rate can’t go any lower.
Without the Ricardian assumption it all comes apart, best i can tell so far.
And most economists reject that assumption as it means you could cut taxes all you want with no effect as people don’t spend in anticipation of higher taxes later. So that argues for cutting taxes to 0, since it won’t change spending.
So what they do is break the world into Ricardian and non Ricardian agents, and then try to determine effects of deficit changes, etc.
It gets very silly. Especially when recognizing there is no ‘natural force’ that balances the budget over time, while there are ‘natural forces’ (further influenced by institutional structure) that promote the accumulation of net financial assets in the non govt sectors which can only be supplied by govt deficit spending.
It comes from not understanding the currency itself is a (simple) public monopoly, and not just a numeraire in a relative value new Keynesian model.
A new analytical low for the cycle and a black mark for the NY Fed:
Link
Federal Reserve Bank of New York
Staff Reports
What Fiscal Policy Is Effective at Zero Interest Rates?
Gauti B. Eggertsson
Staff Report no. 402
November 2009
Abstract
Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures. Another example is a cut in capital taxes. This tax cut deepens a recession because it encourages people to save instead of spend at a time when more spending is needed. Fiscal policies aimed directly at stimulating aggregate demand work better. These policies include 1) a temporary increase in government spending; and 2) tax cuts aimed directly at stimulating aggregate demand rather than aggregate supply, such as an investment tax credit or a cut in sales taxes. The results are specific to an environment in which the interest rate is close to zero, as observed in large parts of the world today.
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November 13th, 2009 at 7:22 pm
Nothing makes me wanna save less and spend more than a brand new “investment tax credit.” WTF?! Have these economists ever met real people?
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November 13th, 2009 at 9:30 pm
warren i just saw mike normans website and he is recommending shorting the market as obama deficit cutting pledge will lead to disaster. Historically how long wil it take for this to be seen in the economy.
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November 14th, 2009 at 6:34 am
timing is everything on shorting the stock market.
also, i’m not close enough to the companies to know what forecast they are already pricing in.
and if he’s right bond yields should fall as well, which might be the easier trade, but, again, I don’t give direct trading advice on this website
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November 14th, 2009 at 4:13 pm
Yeah, stock markets may even cheer up on the news - thinking low deficits is great. It may take a while for the bad effects to happen to the markets, when profits numbers are declared next year. Direct impact such as unemployment increase can happen fast.
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November 14th, 2009 at 9:17 pm
the ricardian equiv assumption the fed guy is making says that if a guy is behind in his mtg payment and he gets a tax cut he’ll save it rather than make the payment because he knows taxes must go up later.
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November 15th, 2009 at 4:01 am
The Ricardian equivalence and the ideas like that are difficult to get out of people’s head. Even if people appreciate national and reserve accounting a bit, they fall pray to statements like private sector will save rather than spend. It becomes difficult for them to digest the fact that the deficit can be increased to even higher levels that the private sector’s saving desire has been satisfied and they start spending. But the author must have worked a while at the Fed and other places and studied a lot - so a black mark really.
Warren there was however a good paper I saw recently at the NY Fed site http://www.newyorkfed.org/research/current_issues/ci15-4.pdf so probably the Fed is not all that bad. One of the authors is the same person who you mentioned a few months back. (Why are banks holding so many excess reserves). It builds the story of the crisis as a Repo Run and the measures the Fed took.
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November 15th, 2009 at 7:57 am
Yes, agreed. That paper was very constructive.
The payroll tax paper is one that somehow got by the censors.
I don’t think they would have published it if they were aware of that assumption.
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November 15th, 2009 at 12:46 pm
Can someone contact the “fed guy†Eggertsson and ask him what he would do if his net personal wealth quadrupled as a result of being given the requisite number of dollars or Treasuries?
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November 15th, 2009 at 7:53 pm
Google Gauti, Bernanke, Michael Woodford, and Brian Sack and Zero-bound, and you’ll discover just how influential Gauti’s views are within the Fed. These guys have written or edited dozens of papers and books together. So Gauti is no outlier. He’s an elite member of the Bernanke “brain” trust.
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