Wednesday, January 23, 2008

Fiscal Stimulus on the Way

Peter Baker and Jonathan Weisman report in the Washington Post that Bush Pelosi Reid and Boehner are putting partisan differences aside to bite the bullet and cut taxes. I actually agree with most of what they are doing. Also I found the article highly informative.

The main proposal is a one off rebate with checks to be mailed immediately with the aim of causing consumption to increase right now, which is good if monetary policy is insufficient to prevent a recession (I see plenty of space between a 3.5% target federal funds rate and the liquidity trap so I'm not sure fiscal stimulus should be used before the monetary pedal is to the medal* but it's coming and the only debate is will it make sense as fiscal stimulus). The problem with fiscal stimulus is that most people will save most of the money so it will cause a small permanent increase in consumption not only in the near future with possible insufficient aggregate demand but also in the medium term with consumption crowding out investment.

The solution, of course, is to send the money to people who will spend it right now which means poor people especially people who are temporarily poor. The Bush administration appears to have abandoned the principle of anti egalitarianism at all cost and agreed to let congress send money to people who will actually spend it now (because they really need it right now).

They also are reintroducing accelerated depreciation to encourage investment. This was one of Reagan's policies in the early 80s. As implemented then, it was a disaster, because it was a subsidy principally for capital goods which don't really depreciate, that is, structures. The result was a lot of empty office buildings -- a commercial real estate bubble (followed by a crash and the S&L crisis). Just like the Bush administration to deal with a bubble bursting by trying to blow another.

I think the investment tax break will only apply to investments in the near future. this makes sense as the distortion will be small and the stimulus large as it partly will consist of speeding up investment planned for the future.

Of course, the distortion of an investment incentive doesn't have to be so bad. There is a reasonable case (based on real live evidence) that a subsidy to investment in equipment (as opposed to buildings) causes an improvement over laissez faire. Like that's ever going to happen (certainly not when there is a slow down concentrated in construction).

I'd say that if the checks to the poor are as large as the checks to the non poor (full refundability of the one off tax credit) that this is good news. If, in the end, the poor get the scraps (and how well have Democrats negotiated with the Bush administration and congressional Republicans so far) then it is bad news.

update: Pelosi caves. Checks go only to workers and not to the unemployed. this in exchange for refundability, that is, even those who don't pay income tax get checks. Also the bipartisan plan does not extend unemployment benefits or spend more on food stamps, the investment incentives apply to plant as well as equipment (no surprise). Now why the hell did Pelosi have to reach a bi-partisan compromise ? She could have forced the plan she wanted through the House and have Reid negotiate. Now he will compromise between her compromise and the Bush plan in the Senate.

* I meant metal. I kan't spelll

1 comment:

Anonymous said...

please don't take this question as critical, but you state "pedal to the medal" Is that different from "pedal to the metal" (referring to an auto's accelerator pedal).
Just trying to keep up with current lingo.