Aug 122009
Aug 122009
Tax cuts on consumption and government consumption have a relatively immediate impact both on aggregate demand and on the rate at which balance sheets are repaired, and income tax cuts along with spending on infrastructure are better at enhancing long-run growth. Thus, my view is not that the tax cut component in the current stimulus package was a complete mistake, tax cuts can help to shorten recessions as described above, and this effect occurs both because tax cuts help to repair balance sheets when the tax cuts are saved, and because they stimulate consumption. But the effectiveness of the tax cuts in the short-run could have been improved by targeting consumption rather than income, and government consumption may have had an even larger effect. What I haven’t been able to determine, however, is which type of tax cut, income or consumption, has the bigger effect on balance sheet repair (saving) rather than aggregate demand (consumption), though I suspect that income tax cuts would have the larger balance sheet effect.
The biggest mistake is that the government consumption component was much too small. The package should have been much larger, and proportionately more of the package should have gone to government consumption measures (which do not have to wait until projects are “shovel-ready” before they can be implemented) rather than income tax cuts and infrastructure. The package contained more than enough measures devoted to long-run economic growth, but far too few devoted to simulating aggregate demand immediately.
Spending Versus Tax Cuts by Mark Thoma
At least one observer has argued that the current recession is not as bad as that of the 1980-82 recession, when those two separate recessions (1980Q1-1980Q3; 1981Q3-1982Q4) are considered as one (see [1] [2]). Here is my interpretation of this assertion, updated to use the latest GDP data, and normalizing (log) GDP on the recession start dates.
Figure 1: Log GDP relative to 2007Q4 (blue), log forecasted GDP relate to 2007Q4 (teal), and log GDP relative to 1980Q1 (red). Source: BEA GDP 2009Q2 advance (July 2009), WSJ survey of forecasters (July 2009), NBER, and author’s calculations.
Notice that, using the WSJ mean survey forecast from early July, the current downturn will exact a bigger (percentage) output loss than the 1980Q1-1982Q4 recession; if we assume the current recession trough ends up being 2009Q2, then the cumulative loss relative to previous peak will be 9.6 percentage points, while that for the “1980-82 recession” will be 2.5 percentage points.
Originally published at Econbrowser and reproduced here with the author’s permission.
The oversight panel — led by Harvard law professor Elizabeth Warren — acknowledged the difficulty confronting Paulson and his team.
The report said while 18 of the 19 large institutions that underwent “stress tests” by the Federal Reserve in the spring probably are prepared to handle a downward turn in the economy, smaller banks would have a substantially more difficult time.
Those banks may need to raise an additional $12 billion in capital to guard against mortgage loans going bad, the report states.
Banks face continued stress from the billions of dollars in toxic mortgage assets still on their balance sheets, a congressionally appointed watchdog said Tuesday, something that could prompt the Treasury Department to expand its rescue programs. [Read More]
