Monday, 26 July 2010

Fiscal adjustments can’t be made quickly? Rubbish.

The conventional wisdom that fiscal adjustments cannot be made quickly, whereas monetary ones can, and hence that this is an advantage of monetary policy over fiscal policy. For example this article in The Economist makes the claim (2nd para).

Plus the claim appears on this economics tutorial site (under the heading “Differences in the lags…”)

This claim is very questionable.

It may well be that there are several types of tax which cannot be change quickly. But that is irrelevant. The important question is whether there are ENOUGH types and of sufficient size that CAN be changed quickly. Enough, that is to make the requisite changes to aggregate demand.

Well the U.K. reduced the Value Added Tax percentage around eighteen months ago and then increased it about six months ago. Moreover, the percentage change was only 2.5%, that is one eighth the total VAT percentage of 17.5%. I.e. the U.K. could have made EIGHT TIMES as big a change had it wanted to.

And for another quick fiscal change, Warren Mosler one of the most pro-deficit economists has long advocated a payroll tax reduction or abolition.

Plus it would be possible to temporarily suspend the payroll tax AND abolish a sales taxes, like VAT.

Retail chains can make changes to their prices at the press of a button. They can charge a different price for a given product at different stores if they want. It’s time governments learned to do the same sort of thing.

It would be perfectly feasible to change a payroll tax or sales tax from month to month (not that they would need to change that frequently). And if any “it’s never been done before” bureaucrats don’t like the idea, they should be replaced with people who CAN do things that have never been done before.

And finally we should never forget a nonsensical aspect of monetary changes. Cutting interest rates, for example, boosts the economy ONLY via firms and organisations that are, substantially in debt, AND rely to a significant extent on variable rate loans rather than longer term loans. This is no different from boosting an economy only via firms whose names begin with letters between A and F.

In contrast, a fiscal boost can be given to much wider sections of the economy, e.g. a payroll tax change effects ALL employers.

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