by Tax cuts won’t do it Stuck in the present ‘secular stagnation’ looking situation, politicians and economists have to make some choices if they want to get the economy going. From a Keynesian perspective one could perhaps contemplate (A) central banks lowering interest rates and doing some quantitative easing (B) governments cutting taxes and increase budget deficits (expansive monetary policies) (C) governments expanding through spending of their own (expansive fiscal policies) The first option is not a serious possibility when the economy is near the zero lower bound and the liquidity trap is slamming. Monetary policies run out of effectiveness in that situation. No injections what so ever that the central bank makes will generate the necessary
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Tax cuts won’t do it
Stuck in the present ‘secular stagnation’ looking situation, politicians and economists have to make some choices if they want to get the economy going. From a Keynesian perspective one could perhaps contemplate
(A) central banks lowering interest rates and doing some quantitative easing
(B) governments cutting taxes and increase budget deficits (expansive monetary policies)
(C) governments expanding through spending of their own (expansive fiscal policies)
The first option is not a serious possibility when the economy is near the zero lower bound and the liquidity trap is slamming. Monetary policies run out of effectiveness in that situation. No injections what so ever that the central bank makes will generate the necessary inflationary impulses.
The effectiveness of the second option hinges on people actually spending the money they get through tax reductions. Today, with seriously indebted households and firms, much of the money will simply be used to pay down debts. Although the effectiveness to quite a large extent depends on who gets the cuts and if the cuts are ‘hit and run’ or more permanent, interest rates and monetary policy actually matter little when we’re in a kind of balance sheet recession where many companies and households find themselves carrying excess debt that they have to pay down. The number of willing private borrowers are few – even when interest rates are at zero – and as a result of this a tax cutting monetary policy by itself has little expansionary force.
Increased liquidity will not not always and everywhere get us out of a recession. This seems to be something that even people like Greg Mankiw nowadays have come to realize. If we really want to get the economy going in the years to come, tax cuts will not be the magic bullet. Tax cuts are not delivering growth rates of 4-5 % or lowering unemployment rates to 2-3 %.
Tax cuts won’t do it. So we’re actually only left with the third option. The only way forward is to use expansionary fiscal policy. Unfortunately that takes courage and vision — something not exactly übersupplied with today’s ‘expansionary austerity’ politicians and central banks …