Mark Thoma posts this graph
In early 2008 I said
Inflation is here, yes. Commodity prices in general and agricultural prices are skyrocketing. This is something that we talked about here last year. However, the Japanese Scenario is becoming more salient everyday.
As I say regularly to my colleagues, “This is not just sub-prime, this is not just housing. This will get much worse before it gets better.”
The reason I point this out is that the basic path of the recession was totally foreseeable if you paid attention to the incoming data on liquidity demand.
This is key because we are now engaged in a great debate on how to get out of this crisis. I maintain that the type of analysis that foresaw a crisis of this exact nature coming should be given extra weight.
If the people who were saying in early 2008 that a severe liquidity crisis was brewing were correct, shouldn't this at least raise somewhat the general estimates that resolving the liquidity crisis is the key to growth.
I know there are a lot of people who point to federal government policy uncertainty. Who knows what Obama might do? However, policy uncertainty didn't predict the crash while liquidity concerns did.
As such I strongly suggest that those who are committed to bringing us out of recession focus their attention on liquidity.
That having been said there are numerous ways of dealing with this:
1) Obviously I have pointed to higher inflation targeting. I am still a big fan of this and I think at the core a credible promise to induce inflation is the ultimate key.
2) I endorse QE 2, like many I am skeptical of why the Treasury couldn't just buy up all of our long term debt, issue T-bills and receive the same benefits. However, if it serves as a communication devise that the Fed is serious about reducing long term rates then I am for it.
3) Tax cuts. I know for many of my liberal readers this is increasingly becoming a bad term. However, the point is not whether we concede to a so called "republican" idea, the point is whether we reduce unemployment for those in need.
I have argued and will continue to argue if that for some reason, that I don't completely understand, the markets fail to take the Fed seriously we still have the option of injecting large amounts of liquidity quickly through tax cuts.
Please, lets not get hung up on whether tax cuts are an excuse to hand out money to the rich. We can cut payroll taxes. We can even provide a payroll tax credit where you get back the first 5000 your family paid in payroll taxes.
I am indifferent to the structure. What matters is that we get funds into the hands of consumers. What matters is that we end the liquidity crisis and reverse the upward trend in unemployment.
I know that you would prefer infrastructure, but every day we wait is another day that many of our citizens goes without a job. Lets act quickly, boldly and in accordance with the experience and models that we have available.
It might be nice if we figured out a complex dignity voucher, skill building program that retrains Americans for a new service based economy. However, of primary importance is that the millions of Americans who are desperately looking for gainful employment find it.
We have the power to accomplish this. However, to do it we must lay down our partisan shields and accept any means necessary for moving us out of the liquidity trap.
Unless there is a macroeconomic reason you believe they will fail, please endorse tax cuts as an option. Share this: StumbleUpon Digg Reddit
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Thursday ~ October 21st, 2010 at 10:57 am
Karl, do you share Eggertsson’s concerns that it is very important to pick the right taxes to cut? Eggertson says wage and capital tax cuts can be harmful in a liquidity trap, on the other hand, sales tax cuts and investment tax credits can be very effective: http://www.newyorkfed.org/research/staff_reports/sr402.html
Thursday ~ October 21st, 2010 at 12:01 pm
If the Fed is determined not to let inflation fall below a certain level, and perhaps even to temporarily raise the inflation rate, then I don’t think the deflationary pressures of a supply-side tax cut are a concern unless you doubt the Fed’s ability (or will) to fight disinflation/deflation. And if the Fed does in fact have the ability and the will to prevent a free fall in the inflation rate, then wouldn’t the deflationary pressures of a supply-side tax cut show up as increased aggregate demand as the Fed is forced to boost AD by a greater amount to compensate for those deflationary pressures?
If your concern is the Fed’s ability to create higher inflation, and you want tax cuts as a way to combine fiscal and monetary policies to make the Fed’s AD-boosting powers more effective, then I can see how certain tax cuts would be better than others.
Thursday ~ October 21st, 2010 at 12:45 pm
Alexander,
Here we are discussing a case where fiscal and monetary policies are combined. I believe Eggertsson’s paper ignores the channel whereby supply side tax cuts reduce credit spreads by healing private sector balance sheets. In early 2009 credit spreads were exploding, so at that time supply side tax cuts were an excellent option. But now credit spreads are in a normal range so perhaps the importance of supply/demand side tax cut distinction has increased.
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