Fiscal and Monetary Policy
Global Unemployment
• Approximately 14 million Americans are
jobless
• 21 percent of Spanish workers are
unemployed
• O.E.C.D. on high unemployment “The room
for macroeconomic policies to address these
complex challenges is largely exhausted.”
OECD forecast for inflation
U.S. CPI
Core Inflation is Low
The Wage-Price Spiral: Not Happening
The overhang of private debt
Why some inflation might be good
• And a period of modestly higher inflation
would help reduce that private debt overhang,
which would help promote economic
recovery, which would in turn raise revenues
and help the fiscal situation.
Via Macroeconomic Advisers
A fiscal response
• 1. A fiscal response to a severe slump only
requires unusual action while the situation
remains grave.
2. Fiscal policy is not wholly dependent on
expectations changing for its effect
Adam Posen of the Bank of England
• The UK’s economic performance over the past year is no surprise. When
you tighten fiscal policy significantly after a major financial crisis, both
history and mainstream economics would tell you to expect what we have
now : no growth in broad money or credit, persistently high interest
spreads for small businesses and households, flat or contracting private
consumption and retail sales, a dearth of construction and declining real
wages – all only partially offset by some expansion in exports. In such a
situation, you should expect little domestically generated inflation, and
that is also just what the UK has.
• The recent consumer price inflation rates above 4 per cent result from this
year’s value added tax increase and the recent energy price shock.
Removing those factors, UK inflation has averaged 1.5 per cent over the
past year – including any remaining effects of sterling’s past decline. Of
course, higher taxes and energy prices shrink British real incomes, but the
monetary policy committee was right not to respond to them, and should
not do so now.
From Bloomberg (5/2011)
• U.K. business confidence declined in March to the
lowest in two years, suggesting the economy may
struggle to gather strength in the second quarter.
• A gauge of sentiment, which aims to predict
economic developments four months in advance, fell
to 1 from 3 in February, London-based Lloyds
Banking Group Plc (LLOY) said in an e- mailed
statement today. The share of companies that were
less optimistic about economic prospects increased
to 44 percent from 36 percent in the previous
month.
A case for fiscal stimulus
Liquidity Trap
Bernanke’s Press Conference
OECD on US monetary policy:
“In the United States, where some long-term
measures of inflation expectations have
increased and the labour market has stabilised
earlier than expected, the start of normalisation
[by which they mean raising interest rates] should
not be delayed beyond the last quarter of 2010.
Policy interest rates should be well above halfway to neutral by end-2011, but the path of
convergence to full normalisation would have to
accelerate if long-term inflation expectations
were to drift up further.”
Friedrich August von Hayek, T.E. Gregory, Arnold Plant, and Lionel Robbins on October 18, 1932.
•
•
•
We are of the opinion that many of the troubles of the world at the present are
due to imprudent borrowing and spending on the part of the public authorities.
We do not desire to see a renewal of such practices. At best they mortgage the
Budgets of the future, and they tend to drive up the rate of interest--a process
which is surely particularly undesirable at this juncture, when the revival of the
supply of capital to private industry is an admittedly urgent necessity. The
depression has abundantly shown that the existence of public debt on a large scale
imposes frictions and obstacles to readjustment very much greater than the
frictions and obstacles imposed by the existence of private debt.
Hence we cannot agree with the signatories of the letter that this is a time for new
municipal swimming baths, etc., merely because "people feel they want" such
amenities.
If the Government wish to help revival, the right way for them to proceed is, not to
revert to their old habits of lavish expenditure, but to abolish those restrictions on
trade and the free movement of capital (including restrictions on new issues)
which are at present impeding even the beginning of recovery.
1937 Prices
The Mistake of 1937
Budget balance, in millions of dollars, red line, right scale; long-term interest rates, blue line, left scale:
1937 and interest rates
• deficit came after the slump began, not before
• bigger deficits never did push rates up.
Stimulus math
• Obama stimulus plan probably cut less than 2 percentage points off
the average unemployment rate for two years
• The starting point for this discussion is Okun’s Law, the relationship
between changes in real GDP and changes in the unemployment
rate  Okun’s Law coefficient : it says that you have to raise real
GDP by 2 percent from what it would otherwise have been to
reduce the unemployment rate 1 percentage point from what it
would otherwise have been. Since GDP is roughly $15 trillion, this
means that you have to raise GDP by $300 billion per year to reduce
unemployment by 1 percentage point.
• Obama plan calls for $787 billion over two years, with $300 billion
in tax cuts and the rest in spending. Call that $150 billion per year in
tax cuts, and about $240 billion each year in spending.
• How much do tax cuts and spending raise GDP?
Bang for the Buck
•
Fiscal Bang for the Buck
•
One-year $ change in real GDP per $ reduction in federal tax revenue or increase in spending
•
Tax Cuts
•
Nonrefundable Lump-Sum Tax Rebate 1.02
•
Refundable Lump-Sum Tax Rebate 1.26
•
Temporary Tax Cuts
•
Payroll Tax Holiday 1.29
•
Across the Board Tax Cut 1.03
•
Accelerated Depreciation 0.27
•
Permanent Tax Cuts
•
Extend Alternative Minimum Tax Patch 0.48
•
Make Bush Income Tax Cuts Permanent 0.29
•
Make Dividend and Capital Gains Tax Cuts Permanent 0.37
•
Cut Corporate Tax Rate 0.30
•
Spending Increases
•
Extend Unemployment Insurance Benefits 1.64
•
Temporarily Increase Food Stamps 1.73
•
Issue General Aid to State Governments 1.36
•
Increase Infrastructure Spending 1.59
Source: Moody's Economy.com
Multiplier
• Mark Zandi of Economy.com indicate a multiplier of around 1.5 for
spending, with widely varying estimates for tax cuts. Payroll tax
cuts, which make up about half the Obama proposal, are pretty
good, with a multiplier of 1.29; business tax cuts, which make up
the rest, are much less effective.
• In particular, letting businesses get refunds on past taxes based on
current losses, which is reportedly a key feature of the plan, is
lump-sum transfer with no incentive effects.
• Assume that the overall multiplier on tax cuts is 1. Then the peryear effect of the plan on GDP is 150 x 1 + 240 x 1.5 = $510 billion.
Since it takes $300 billion to reduce the unemployment rate by 1
percentage point, this is shaving 1.7 points off what unemployment
would otherwise have been.
“Full employment”
• “Full employment” clearly means an
unemployment rate near 5 — the CBO says
5.2
• Unemployment is currently about 9 percent,
and heading much higher