Sunday, February 8, 2009

From Textbook Stimulus Fallacy to Dow 10,000

Missing Tax Cut Multipliers Make all the Difference
There is, it seems, a fallacy in textbook economic theory. Harvard economist and best selling textbook author Greg Mankiw points out in the New York Times that while textbook Keynesian economics suggests federal spending is more effective than tax cuts at stimulating the economy, empirical evidence suggests otherwise.
Economics textbooks, including Mr. Samuelson’s and my own more recent contribution, teach that each dollar of government spending can increase the nation’s gross domestic product by more than a dollar. When higher government spending increases G.D.P., consumers respond to the extra income they earn by spending more themselves. Higher consumer spending expands aggregate demand further, raising the G.D.P. yet again. And so on. This positive feedback loop is called the multiplier effect.
In practice, however, the multiplier for government spending is not very large. The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States’ historical record, Professor Ramey estimates that each dollar of government spending increases the G.D.P. by only 1.4 dollars. So, by doing the math, we find that when the G.D.P. expands, less than a third of the increase takes the form of private consumption and investment. Most is for what the government has ordered, which raises the next question.
WILL THE EXTRA SPENDING BE ON THINGS WE NEED? If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the G.D.P. rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off... If the stimulus package takes the form of bridges to nowhere, a result could be economic expansion as measured by standard statistics but little increase in economic well-being...
MIGHT TAX CUTS BE MORE POTENT? Textbook Keynesian theory says that tax cuts are less potent than spending increases for stimulating an economy. When the government spends a dollar, the dollar is spent. When the government gives a household a dollar back in taxes, the dollar might be saved, which does not add to aggregate demand.
The evidence, however, is hard to square with the theory. A recent study by Christina D. Romer and David H. Romer, then economists at the University of California, Berkeley, finds that a dollar of tax cuts raises the G.D.P. by about $3. According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases.†
Why this is so remains a puzzle. One can easily conjecture about what the textbook theory leaves out, but it will take more research to sort things out.
One wishes Prof. Mankiw would do a bit more informed conjecturing in the Times, because the answer to the above puzzle could greatly inform the current stimulus debate. It is likely there is more than just one factor at play here. Prof. Mankiw at least offers one explanation here why the multiplier for spending stimulus may be so low: too many bridges to nowhere, too much useless digging-and-filling ditches drags down the spending multiplier. But hidden elsewhere in his blog, Mankiw more powerfully explains the higher multiplier for tax cuts:
One hypothesis is that that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favorable to capital investment--a mechanism absent in the textbook Keynesian model.

Suppose, for example, that tax cuts... take the form of cuts in payroll taxes (as suggested by Bils and Klenow). This tax cut would reduce the cost of labor and, if labor and capital are complements, increase the demand for capital goods. Thus, the tax cut stimulates demand not only by increasing disposable income and consumption spending (the textbook Keynesian channel) but also by incentivizing more investment spending. A similar result might obtain if the tax cut included, say, an investment tax credit.††
All the above clearly applies to the current debate over whether corporate tax cuts should be included in the stimulus package, with critics making the same textbook arguments that businesses might save rather than invest the tax cut, while federal spending is surely spent.

However, it seems to me that when the Mankiw hypothesis is applied to corporate tax cuts, (which is a cleaner thought experiment than a payroll tax in that we don't need to consider the employee tax cut) not only does it become crystal clear that Mankiw MUST be right about price changes boosting investment demand, but that there is an additional market mechanism in play here, boosting both aggregate demand and hence the tax multiplier.

Let's follow the chain of cause and effect: corporate tax cuts would mean higher after-tax earnings; since earnings determine stock prices through P/E ratios, higher earnings forecasts would signal a immediately higher market value for each corporation and the stock market as a whole. Rising values will pull investors back into the market. Further, a rising stock market generally means rising consumer spending and demand as individual see their net worth recover and deferred needs become pressing. Lastly, rising demand would further determine that corporate tax cuts would be invested, not saved, again, in direct contradiction of the above textbook expectations.

How does this work out in the current market? Doing the math, we see that cutting combined federal-state corporate rates 15 percentage points from the present 39% to say 24% (making US rates in line with average corporate rates in OECD countries) would raise corporate after-tax earnings by about 24.6%. If P/E ratios are stable, it is likely that both corporate valuations and stock markets would rise by roughly the same percentage, around 24.6%, in a fairly short period. If the current market floor is at about DOW 8000, that implies that a 15% corporate tax cut would raise the value of the DOW to just under 10,000. This number could be higher if P/E ratios rise (as is usually the case in rising markets) or if a significant portion of investors use leverage. Subsequent rising demand could further boost the Dow significantly above 10,000, driving a powerful positive feedback loop that boosts demand and GDP further.

While I leave it up to others to quantify tax cut multipliers, it is easy to see where additional equity and debt market multipliers kick in, and what has been left out of the textbook theory: some of the new investors will use debt for leverage (creating an additional credit market multiplier) or pull money out of savings (in contradiction to textbook models that result in low multipliers). Further, as with the new investment, the new consumption will also be partly financed from debt or savings, credit markets again boosting demand and the tax multiplier. Lastly, facing stronger demand, businesses would not only invest their tax cuts, but seek more equity and debt financing, creating an additional leverage multiplier. Higher stock valuations (the direct result of tax cuts) would further strengthen balance sheets and allow corporations to borrow more money more cheaply.

At nearly every step of this chain of causation, we further see that the textbook Keynesian assumption that the tax cut will be saved rather than invested is powerfully contradicted, that the tax cut would be not only fully invested but also attracts additional debt or equity financing at three different levels: that of the investor, consumer and corporation.

By contrast, no such equity+credit market multiplier effect could be plausibly attributed to federal spending, which seems instead to actually crowd out private investment.

Prof. Mankiw observes:
This hypothesized channel seems broadly consistent with the empirical findings of Blanchard and Perotti, Mountford and Uhlig, Alesina and Ardagna, and Alesina, Ardagna, Perotti, and Schiantarelli.
He refers to his own hypothesis, of course, but it is equally true of my elaboration on equity and debt market multipliers, and probably applies to a broad variety of tax cuts (and regulatory relief) that effect the value of investments. This hypothesis could be further verified if research shows the following: (a) that corporate tax cuts lead to rising stock markets; and (b) that rising stock markets lead to rising consumer spending.

To correct the spending stimulus fallacy, future economics textbook should say that every dollar of federal spending is either spent or misspent, but every dollar of tax cut is not only invested, but attracts many more dollars of additional investment by raising underlying valuations.

Addendum: So why post this here on a blog about green energy tax cuts? Because not only is the proposed stimulus worth writing about, but all the above bolsters the case for supply-side green tax cuts, which should also boost GDP by $3 for every dollar of tax cut, according to the empirical research cited above. I can't help noticing that Mankiw is the founder of The Pigou Club, arguing for Pigouvian tax adjustments to take into account market externalities. Now this may come as a surprise, but I am applying for admission to the club on the grounds that green tax cuts are indeed a legitimate Pigouvian tax adjustment to account for positive and negative externalities of various energy technologies. That I oppose carbon or gas taxes on account of the $3 of GDP loss they create for every dollar of tax, or believe Pigouvian tax cuts are superior to Pigouvian tax hikes is merely a matter for thought-provoking internal debate among club members, and should not bar me from admission, or full enjoyment of club facilities...

†Prof. Mankiw points to other empirical evidence of low spending and high tax cut multipliers here, here and here. Christina Romer is President Obama's appointee as chairwoman of the Council of Economic Advisors.

††Mankiw's hypothesis is similar to the explanation offered by supply-side economics: tax cuts make it more rewarding to work and invest, and less rewarding to employ accountants and tax shelters: therefore a tax cut gets us more work and investment. But supply-siders go one step further by suggesting that the highest tax multipliers are associated with cuts at the highest marginal rates, that since the highest rates create the severest disincentives to work and invest, the magnitude of the economic benefit for a cut at these rates will be greatest, as will the likelihood that such cuts will be revenue positive or neutral.


Unknown said...

The claim regarding crowding out private investment is actually irrelevant now. That paper looks at "dynamic effects of shocks in government spending and taxes on U. S. activity in the postwar period"

Note the 'postwar'. I doubt that even the authors would suggest their paper is relevant in the current climate; the current climate is more like the prewar Great Depression.

The private sector is running away; there is no private sector to be crowded out. When facing major recessions, multipliers for government spending are high and are higher than those for tax cuts.

Rod Randolph Richardson said...

Aaron: Thanks for the comments from Dublin!

The idea that "there is no private sector" seems a bit of an overstatement. Your argument that we are now in a period like the Great Depression is an unproven assertion. The hypothesis that recession and depression changes the multipliers is interesting, but would be more convincing if you had some empirical data from recessions and depressions to back it up.

Absent the above support for your views, I don't see a reason to think that the empirical multipliers would not have at least some similar effect in present circumstances. If spending multipliers crowd out private investment in good times, surely they are not going to spur private investment in bad times. The only way to spur private investment is tax cuts. So at very least, we need a good mix.

Now I note that in Ireland, you have one of the lowest corporate tax rates around at 12.5%, (vs US 39.5%) yet you bring in more tax revenue as a share of GDP, as do most OECD countries. Therefor, it seems clear the US can lower our corporate rate and significantly spur the markets and the economy, and there is good reason to think the tax cut will be revenue positive or neutral.

Unknown said...

I should probably give the obvious disclaimer: I don't have any economics qualifications or experience. I'm just a very interested armchair amateur economist :-)

On many metrics, we are about to face into the Greater Depression unless drastic action is taken. One example is the debt-to-GDP ratio which is even higher than it was before the Great Depression. This is one such graph: you can find many more:

Anyway, returning to the main issue, and to my hypothetical ramblings :-). I don't think anyone would deny that when any money is spent, there will be a chain reaction where the total of money spent is larger than the original amount. The disagreement is over how much of that activity is 'new' activity, or is simply a change in plans. Put crudely, perhaps the government drags builders from private sector building sites to build bridges and perhaps the builders would have bought cars with their pay packets anyway.

In a booming economy with high employment, it's hard to see how the government can create any new or better output. And hence, government spending can do harm.

But I propose that in a serious recession it's quite likely that this spending will indeed create 'new' output by reemploying or saving jobs. For example, a construction worker whose job has just been saved by grants to their state is a worker who is likely to decide to buy that new car he has delayed buying.

The discretionary purchases, such as automobiles, are the first to go when consumption falls and hence will be the first to rebound if consumption increases. Unless of course the worker, in his wisdom, wants to buy something else; this is where the free market is still alive and well. The troubled sectors are where the bargains are to be had, so can be expected to attract some of the multiplier spending when the workers start spending. This way, the multiplier spending is (re)employing workers and increasing output, which is good news for everyone.

Tax cuts give money to people who already have jobs, and they are already likely to be spending no more, and no less, than they want to. But unemployed people will be spending very little, and can be relied upon to increase consumption if given a job. Similarly, if somebody loses their job their consumption will decrease dramatically.

This is why we need to target the money to create jobs, or to save jobs that would definitely be lost. They will be most likely to spend it, increasing consumption, output, and probably investment too.

In the good times, workers will spend a tax cut. In bad times, they'll save it.

Sorry for the long post - I've yet to compose a more succinct version of this argument!

Unknown said...

I don't think I'll often quote the IMF, or the WSJ, but the IMF head has said that "we are already in depression"

Further evidence that we need to look at centuries of economic history, not just the last decade or two of mini-recessions, to get a handle on this crisis.

Rod Randolph Richardson said...

Aaron: As i said, I think we need a mix. I am not denying the usefulness of working on infrastructure, etc., during a downturn. But you should not ignore or misunderstand the power of investment related tax cuts to create change and jobs.

If you increase the earnings of an investment, as through a tax cut, you automatically increase its market value. That lifts markets. Doing so, puts a lot more money in people's pockets, who certainly will spend more. That will put many, many more people back to work than you can accomplish through direct Federal spending.

Let me give you an illustration. When the market crashed in September, big home renovation projects suddenly ground to a halt. Why? Because suddenly homeowners were going to have to liquidate 60% more stock to pay for the same project. So everybody simultaneously pulled the plug on hundreds of thousands of big renovation projects across the US, throwing millions of contractors and construction workers out of work. All of those projects are "shovel ready" and just waiting for the stock market to rebound so people can afford to proceed as planned. That is also true of a lot of big ticket discretionary purchases that people had planned, that have been temporarily deferred pending an improvement in the markets.

The payoff in jobs and rising demand from stimulating markets through tax cuts is potentially huge. So looking at it from the perspective of giving a tax cut to somebody with a job is not very enlightening. You have to look at what it does to the value of the markets and the momentum that then gives to the spending and hiring decisions of shareholders and corporations, which are after all primary sources of normal job creation that must be revived.

Besides, I don't understand why anyone would oppose cutting US corporate tax rates, when clearly they should be cut anyway since they are among the world's highest and least revenue productive.

Rod Randolph Richardson said...

Quote from CNN article on stimulus today:

"But the CBO warned the long-term effect of that much government spending over the next decade could "crowd out" private investment, lowering long-term economic growth forecasts by 0.1 percent to 0.3 percent by 2019."

Probably understated.

Unknown said...

There are a number of claims to be discussed further.

1. Tax cuts increasing market value.
2. Home renovation
3. Corporate tax cuts
4. CBO and long term growth

First, tax cuts on dividends will not have much effect on share prices in the current climate. If I were to own any shares (which I don't) the reason I would avoid bank and automobile shares is because it is possible they will be bankrupt within months. So I don't care if this year's dividend is 10c or 11c if they go bankrupt before paying out. So the most effective way to increase share prices in the current climate, if that's what you want to do, is to decrease the fear of bankruptcy. I'd pay $1 for a company promising a 10c dividend if I was confident it'd survive for decades; but I wouldn't pay more than 20c for a bank share, even if its dividend was to be 15c. An urgent increase in employment and output is the only way to calm nerves about this.

Your argument to the contrary, that corporate taxes and medium term earnings expectation are important, is only relevant in a healthy full-employment economy.

It is good news that home renovation projects have stopped. The US, like many of the English speaking countries, doesn't need any more renovated houses today, particularly as many have probably been rerenovated multiple times. This US probably has a glut of houses, not a shortage of renovated houses. This process of continual renovating and flipping is just the sort of grossly inefficient and destructive nonsense that the private sector can devise when it's high on a bubble. If only half that activity was put into school building, the nation as a whole would be far better off.

Corporate tax cuts worked for the Republic of Ireland because a small cut attracted a massive amount of foreign investment. But the US is already a pretty big economy - a similar cut wouldn't have such a dramatic effect.

Finally, a small drop in GDP in 2019 is not as important as a dramatic increase next year. And a forecast of any kind for 10 years hence is always going to be difficult. Don't forget though, that as the CBO said in that same report:

"More fundamentally, many things that make people better off do not appear in
GDP at all. For example, healthier children or shorter commute times can improve
people’s welfare without necessarily increasing the nation’s measured output in
the long run (though spending in those areas would still provide short-run

A classic recent example is the US's War on Terror. It was a classic piece of Keynesian policies, running deficits to stimulate the war economy. And why did Republicans support this expense? Because of non-GDP things such as the desire to feel safe and also, dare I say it, revenge.

Rod Randolph Richardson said...

If you are interested in saving the auto industry, and how tax cuts might help, you may want to check out my proposal:

But first, I have written elsewhere that tax cuts will not solve the underlying problems in the financial industry, which need to be addressed separately, but they will help the general economy to recover. But your objection that tax cuts won't directly lift the stock price of a specific industry is a flawed argument, because it applies to the current spending bill as well, none of which will lift financial or auto industry shares either. So by that criteria, we should not do spending stimulus either.

Actually, a corporate tax cut will lift shares of all companies with even small earnings, which will boost market values and stimulate demand, and that will help the auto and finance industries.

If you want to lift the shares of key industries with negative earnings, and help them to attract private financing, the way to do that would be to make future gains on those shares capital gains tax free, or future interest on loans tax free, for investments made in the next year. That would not eliminate risk, but it would improve the upside for investors willing to take risk.

Also, most of my argument has focussed on corporate rate cuts rather than dividend cuts, because these will have a broader impact because the rates are simply way too high. Clearly the 39.5% US rate is 13.5 points higher than the 26% non-US OECD average, while OECD corporate tax revenues are 55% higher than US revenues as a percent of GDP. That is crystal clear evidence that the US rate is way too high on the Laffer curve, and we would benefit greatly from a cut. You also mis-characterize the Irish 12.5% tax rate, which is the lowest around, as a "small cut." But I am glad you agree that a corporate tax cut in the US would have an impact, and really, even the "less dramatic impact" you predict is perfectly welcome, thank you very much.

Rod Randolph Richardson said...

As to renovation, with millions of construction workers unemployed, I'd say anything we can do to get a reasonable level of renovations going again would be healthy for the economy. we may have had a bubble, but now things have swung too far the other way. Public works cannot support all these guys for more than a very short period of time. You simply cannot have an economic recovery if your plan is to champion the destruction of the private sector.

Unknown said...

If we're going to continue to use the CBO analysis, we have to look at their estimates of the multipliers. State and Federal spending on infrastructure is most potent in their opinion, followed by tax cuts for middle and lower income.

I'd suggest corporate tax cuts are comparable to "Tax Cuts for Higher-Income People", where the multiplier is estimated to be between 0.1 and 0.5 . Hence, if there were $3 trillion of corporate tax cuts, up to $2.7 trillion might not be spent! Such a cut is profligacy that cannot be afforded now, Americans need some bang for their buck.

Just to clarify, I'm not particularly interested in auto or finance shares to the exclusion of others. I'd like to move towards more sustainable transport and public transport, as would you I guess. And we won't miss many of the banks that will go bust sooner or later. But they are examples of sectors where bankruptcy is a particularly acute fear.

A weak economy with high unemployment, and hence low consumption and low investment, is going to have a low tax take regardless of the tax rates.

I don't know how the CBO have arrived at such low multipliers for tax cuts for the rich, but the standard theory is that the rich (and corporations too, by my guess) will not spend or invest any more than necessary in a recession. Businesses will wait until *after* unemployment is falling and they see consumption rising again before they consider doing any investing or spending themselves.

Unknown said...

"But your objection that tax cuts won't directly lift the stock price of a specific industry is a flawed argument, because it applies to the current spending bill as well, none of which will lift financial or auto industry shares either. So by that criteria, we should not do spending stimulus either."

I never claimed that. It was you that claimed that rising share prices might spur rising output. I simply disagreed with that. My aim is to increase output, that is my criteria. I support direct government spending on things like infrastructure, you suggest cutting taxes on your theory that certain tax cuts would raise share prices and then those share prices increases will then spur spending and consumption.

I don't care about the share prices, I care about the real economy.

As for construction workers involved in renovation, it'd be madness to employ them fovever in renovation as there are just too many of them now. The demand for regular renovation was a temporary fad. Sooner or later, they'll have to find new work as my guess is that the market will not demand their services much longer.

Infrastructure spending is a temporary measure proving temporary relief for construction workers while they find other work, and crucially they will spend their wages supporting up to 1.5 other jobs also (based on the CBO's multiplier of 2.5).

And I'm certainly not championing the destruction of the private sector - the private sector has done enough harm to itself over the last few years without any assistance from me! After we return to a more sane housing market, supply and demand will decide how much renovation is needed. I'm not saying government should speed that up, I'm just making an analysis, like all pundits do, about where I think things might be when the economy has recovered.

Rod Randolph Richardson said...

I only quoted the CBO to show that the proposed spending will have an adverse long term impact, even by textbook models. But the entire point of my post is that the textbook multipliers vastly understate the empirical multipliers for tax cuts, and overstate the multipliers for spending. The CBO estimates are based on textbook theories, not empirical results, and so are likely not accurate.

Empirically, tax cuts have been twice as effective as spending.

Another point you are missing is the likelihood that corporate tax cuts in the US will either be revenue neutral or positive, given the OECD data. This is a powerful stimulus we can do with good reason to think the cost will be small or zero -- or maybe even revenue positive within 3 - 5 years. That is another reason to prefer it to spending stimulus.

Rod Randolph Richardson said...

I don't care about the share prices, I care about the real economy.

As far as i know, the stock market is a big part of the real economy. The stock market always leads the economy out of a recession or depression by several months. That would indicate it significantly helps the economy to recover. So if we help the markets, we help the economy.

So if you care about the economy, you should start to care a bit more about the markets.

Unknown said...

Empirically, since the war (in full employment), maybe tax cuts have better multipliers.

Empirically, in the last depression and WWII, government spending was seen to have the best multiplier.

Even Keynes himself pointed out that stimulus won't work when we have full employment, and recommended an incomes policy (or similar) to avoid inflation. So Keynes is still basically right, and has the evidence of a century on his side.

The stock market only comprizes about a small fraction of the economy. Don't forget all the small businesses and farms.

As far as I know, and these figures may not be up to date, it appears that the S&P 500 only has a market capitalization of $10 tn (that's out of date, probably even lower now), whereas the one year's GDP was $14 tn. Taking the Average P/E of 31, that implies that only 2.5% of all income last year came via the S&P 500.

So the S&P 500 doesn't really matter, except of course to people who have lots of their money invested in it :-)

Share prices may reflect what's going on in the broader economy, but they don't drive it. Someday, hopefully soon, but perhaps in a decade, the US will announce a sufficient stimulus; when that happens share prices will rise.

Can you explain, in a little more detail, how you think a rise in the share price would cause shareholders, or the company itself, to spend more money?

Unknown said...

PS: I should thank you for all your quick and thoughtful comments. I tend to blurt out curt replies when I'm tied up in the details of an interesting discussion!

Rod Randolph Richardson said...

Aaron: As of now, your have yet to produce any empirical evidence to back up this opinion.

I think your numbers on the S&P market cap and P/E ratio are off but do not have the time to check into it now.

Unknown said...

From S&P's own website: its market cap was $13.5tn in 2007. No matter how you look at it, the income of the S&P 500 is tiny compared to US GDP.

Both of us have quoted figures today without immediately linking to authoritative sources, but we both try to fill in the blanks when asked. I don't think either of us can suggest the other is making up figures ("... do not have the time to check into it now ...").

I'm not sure any more exactly what we're disagreeing on. A large number of issues have come up.

My main point is based on the figures from the CBO regarding different multipliers. I have tried to describe some of the theoretical background which would help explain why direct government spending is most effective; and I have left the CBO and others do the tough work of trawling through the evidence to derive the exact figures.

I searched for "stimulus multipliers recession" in Google Scholar and the first interesting result was from the New York Fed.

Their findings are that "This paper shows that at zero short-term nominal interest rate tax cuts reduce output"

So tax cuts could do serious harm to the economy by making deflation even worse. Interest rates are now at practically 0%; only Japan in the 90s and the US in the 1930s faced similar problems, hence this paper is very relevant now.

That paper is marked 'preliminary', so I suppose it might be wrong, however it does fit in perfectly with everything I have heard about economic policy in a recession.

Rod Randolph Richardson said...

2007 US GDP = $13.84 trillion
2007 US Market Cap = $15 trillion

So yes, market cap is very big and significant.

The problem here is that you keep trying to argue the theory (with which I am quite familiar) without quite being able to accept the development that because empirical results do not agree with the theory, it is likely there is a flaw in the theory.

The Eggertsson paper you cite is once again not empirical. It is based on Mr. Eggertsson's personal "New Keynesian" model. Even his multipliers for normal times are contradicted by empirical results, so why should we think his other results are any better? I see the paper is based on a correspondence with Greg Mankiw, which brings us full circle. Here is what Greg has to say:

"Update: Gauti Eggertsson makes the case against supply-side tax cuts in the current environment. But note the caveat that if the tax cuts increase aggregate demand, they are okay in his model as well."

If you read my post above, both Mankiw and I are suggesting that empirical results are explained by the mechanism that tax cuts increase demand before they increase supply: tax cuts increase the value of investments and so stimulating demand for capital goods (stock, etc.) and then demand for ordinary goods as net worth rises. Only then does the tax cut get fully invested, increasing supply, but markets move first.

Unknown said...

You are misinterpreting the Market Cap and GDP figures. They cannot be compared like that, because they don't measure the same thing. An economy that creates output $13tn of GDP each year is an economy that is worth a large multiple of that. GDP is the new output created in a single year.

If a company builds a new factory, that figure is only part of GDP once, but will be part of the Market Cap for many years until it depreciates. So it's not fair to compare the two figures directly. One is an income, the other is the full capital value.

The S&P Market Cap is the sum total of all the value of all the S&P 500 companies. That is why GDP ought to be compared to dividends, or some similar measure, and should not be compared to the market cap. We have to compare like with like.

Are we both agreed that spending will work? And that it will have a higher multiplier that tax cuts? And that the CBO agree with these two points, and that you've quoted no economist who disagrees with any of this?

I think the only real difference of opinion is that I worry the tax-cut multiplier may be negative, and even if it is positive that its multiplier is so low it shouldn't be considered. And that you recommend tax cuts, even though all economists agree they are less effective, and there is no evidence from relevant episodes of economic history that tax cuts will be effective.

If you feel strongly about empirical data, then you must follow that logic through; you must agree that you can't pick and choose the 50 years. The last 50 years is particularly unrepresentative. Surely you agree that policies based on unrepresentative data cannot be taken seriously? The evidence regarding tax cuts being more effective is based on postwar data, and hence cannot be considered relevant.

Even Greg Mankiw uses 'if', he's not sure. He's not sure that tax cuts will increase demand in the current climate. But everyone is sure that spending will work. I'm not aware of anybody who is claiming that the tax-cut multiplier is equal to, or greater than, the spending multiplier. Are you?

Unknown said...

The Romer and Romer paper admits that it is not relevant to the current economic situation:

"The changes not motivated by current or projected economic conditions, which we call
exogenous, are appropriate for measuring the effects of tax changes on output. These exogenous changes
constitute our new measure of fiscal shocks."

Romer and Romer made a consciuos decision to look only at tax increases implemented when the economy was already working well. It is no surprise, on the "if it ain't broke, don't fix it", that any policy change is likely to do harm.

They deliberately, and honestly, chose NOT to analyze tax changes that were implemented in an attempt to fix the economy. Hence they didn't use the data that we need today.

The Romer and Romer paper may be useful for looking at tax cuts in the 90s, or planning tax cuts in the 2020s. But we want to know if tax cuts help in a recession, and this very question is what Romer and Romer did not ask.

Rod Randolph Richardson said...

Aaron: As much as I welcome comments, this is getting a bit exhausting, particularly as you seem to be misreading me, and I do not want to spend a lot of time clarifying.

No, I do not agree empirical spending multipliers are higher, and I cited Mankiw and he cited other economists who think tax multipliers are higher. I do think there is a flaw in textbook theory. I'm not sure why you think I have the opposite opinion.

Mankiw has already addressed the fallacy in your critique of the applicability of Romer's exogenous data here:

Mankiw explains why there is a problem using endogenous data (see link). We will most likely never have reliable endogenous data. But we know that the theory is wrong when predicting multipliers for exogenous tax changes. So why would we assume the theory is right about endogenous tax changes?

Unknown said...

Mankiw's comment that you have linked to said exactly what I expected him to say, so I don't feel I have seen anything to change my mind.

Keynesian theory doesn't attempt to calculate multipliers for exogenous tax changes, hence it cannot be "wrong" on that question.

I think we'll certainly have to disagree to disagree, as neither of us are learning anything from this. It is taking a lot of time. Thanks again though for your patience.

Rod Randolph Richardson said...

Keynesian theory predicts spending multipliers will be higher than tax multipliers, but that is not borne out by what empirical data we have. That seems to be a flaw in the theory.

Anonymous said...

This whole economic argument is pointless. Almost all the technology jobs went overseas and is probably not coming back because the same corporations that laid off these tech workers own the technology that the same tech worker helped create, except some one overseas benefits from the US workers efforts. People like me will stop innovating if there is no long term job incentive. Why should I spend more of my brain power innovating something I know will go to benefit some one else in some other land where we don't get the benefits of profit from such inventions / trade secrets.

The horse has left the barn and for everyone either having a job or otherwise to tighten your belt because this economic downturn is not the old depression. This downturn is because of major corporations moving their centers of operation overseas. No new jobs can be created in these industries because these same corporations also own the technology that goes into the manufactured or end product.

The only sane thing that the US gov can do to stimulate the economy is to revert the patent rights to the original inventors. Thus such inventors can start their own enterprises and make us in the US self sufficient in that aspect of technology.

Of course such a thing will never happen because of corporate lobbyng.

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