My preceding blogpost identified three mistakes made by leaders of the European Economic and Monetary Union in dealing with Greece. But what is done is done. The mistakes now lie in the past. How can Europe’s fiscal regime be reformed to avoid future repeats of this crisis?
The reforms that are now underway are not credible. (“We are going to make the fiscal rules more explicit and make sure to monitor them more tightly next time.”) Similarly, most proposals for how to put teeth into the rules are not credible — penalties such as monetary fines or loss of voting privileges.
Politicians are often tempted to think that a policy to help one goal, say air quality, must also help lots of other goals, say economic growth. Economists are more likely to presume tradeoffs, and to use the principle of targets and instruments. That principle says that you cannot expect to hit more than one bird with one stone, except by coincidence.
At the American Economic Association meetings in San Francisco, January 3, I was on a panel titled “Energy and the Environment: Policy Advice for the New Administration” (along with some real energy experts; I am a relative latecomer to the area). Within the framework of targets and instruments, I proposed a matrix such as the one that appears below. Continue reading →
I am sometimes asked, “Okay, we know that most of the economy is in the tank. But what are one or two sectors where you see potential for growth in 2009?” The conventional response would be “green technologies.” But another sector occurs to me: Intensive Care Units. Continue reading →
Politicians have always faced the temptation to give their constituents tax cuts.But in recent decades “conservative” presidents have enacted large tax cuts that have been anything but conservative fiscally, and have justified them by appealing to theory. In particular, they have appealed to two theories:the Laffer Proposition, which says that cuts in tax rates will pay for themselves via higher economic activity, and the Starve the Beast Hypothesis, which says that tax cuts will increase the budget deficit and put downward pressure on federal spending.It is insufficiently remarked that the two propositions are inconsistent with each other:reductions in tax rates can’t increase tax revenues and reduce tax revenues at the same time.But being mutually exclusive does not prevent them both from being wrong.
The Laffer Proposition, while theoretically possible under certain conditions, does not apply to US income tax rates:a cut in those rates reduces revenue, precisely as common sense would indicate. As detailed in a new paper of mine “Snake-Oil Tax Cuts,” for the Economic Policy Institute, this conclusion was the outcome of the two big experiments of recent decades: the Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03.It is also the conclusion of more systematic scholarly studies based on more extensive data. Finally, it is the view of almost all professional economists, including the illustrious economic advisers to Presidents Reagan and Bush, even though it contradicted the views of their employers.So thorough is the discrediting of the Laffer Hypothesis, that many deny that these two presidents or their top officials could have ever believed such a thing.But abundant quotes show that they did.
The Starve the Beast Hypothesis claims that politicians can’t spend money that they don’t have.In theory, Congressmen are supposedly inhibited from increasing spending by constituents’ fears that the resulting deficits will mean higher taxes for their grandchildren.The theory fails on both conceptual grounds and empirical grounds.Conceptually, one should begin by asking: what it the alternative fiscal regime to which Starve the Beast is being compared?The natural alternative is the regime that was in place during the 1990s, which I call Shared Sacrifice.During that time, any congressman wishing to increase spending had to show how they would raise taxes to pay for it. Logically, a Congressman contemplating a new spending program to benefit some favored supporters will be more inhibited by fears of constituents complaining about an immediate tax increase (under the regime of Shared Sacrifice) than by fears of constituents complaining that budget deficits might mean higher taxes many years into the future (under Starve the Beast). Sure enough, the Shared Sacrifice approach of the 1990s succeeded.Compare this outcome to the sharp increases in spending that took place when President Reagan took office, when the first President Bush took office, and when the second President Bush took office.As with the Laffer Hypothesis, more systematic econometric analysis confirms the rejection of the hypothesis.
These matters are not solely of interest to historians or economists. The presidential campaign of Senator John McCain appears set to drive its wagon down the same road in which Reagan and Bush have already worn deep ruts. The candidate is apparently selling the same snake oil:he says he believes that tax cuts increase revenues.His principle policy director disavows the Laffer Principle, just as the economists who advised Presidents Reagan and Bush did.But the views of the economic advisers are not what determines what these presidents do.
“The Queen in Alice in Wonderland said that, with practice, she was able to believe as many as six impossible things before breakfast.Most of us are more limited in our capacity for credulity.If John McCain believes both the Laffer Proposition (tax cuts raise revenues) and Starve the Beast (higher revenues lead to higher spending, anathema to conservatives), then as a good conservative, his duty is clear.He ought to run on a truly novel platform of higher tax rates!Why?Higher tax rates would reduce revenues (this is what Laffer says would happen) and thereby reduce spending (this is what Starve the Beast says would happen).
So both the Democratic and Republican parties have officially nominated their candidates.Remarkably — from the vantage point of just a few years ago – both Senators McCain and Obama are on record as supporting strong action for aggressive cuts in US emissions of greenhouse gases (GHGs). In June 2008, the floor manager’s version of the Lieberman-Warner bill – S. 2192: America’s Climate Security Act of 2007, which would cut emissions more than 50% by 2050 — came close to passing the Senate.Some think that with the likely Democratic gain in Senate seats in November, and a more supportive White House, a form of the bill may well pass next year.
(Incidentally, the July Snowmass presentations regarding Integrated Assessment models of the effects of such emission-reduction policy plans, which I plugged in my preceding blog post, are now accessible to the public.)
But issues of competitiveness and how to address it have risen to the top in the climate change policy debate among politicians.The Lieberman-Warner bill – would have required the president to determine what countries have taken comparable action to limit GHG emissions;for imports of covered goods from covered countries, the importer would then have had to buy international reserve allowances – equivalent to a tariff. (The same with some of the bill’s competitors such as the Bingaman-Specter “Low Carbon Economy Act” of 2007.)
Menzie Chinn, Prof. of Economics at University of Wisconsin, is guest posting this week:
I want to thank Jeff Frankel for the opportunity to be a guest writer on his blog.
A lot of attention has been devoted to how oil price and food price shocks have affected the US economy, both along the output and price dimensions. A general presumption has been that as long as inflation expectations remain well anchored, then one need not worry about 1970’s style stagflation (recession is another matter).
However, there are many places in the world where inflation expectations are not well anchored. Or at least we can’t tell if they’re well anchored or not. Figure 1 presents data for several key groups (using the IMF classifications): Industrial countries, LDCs excluding oil exporters, oil exporters and developing Asia.
Since I started this blog, my comment section has been inundated with spam. (I am not talking about bona fide comments, most of which have been intelligent and useful.) The spam has reached 35 per night, and it is time-consuming to go through and delete it all. For some reason, my software can’t filter it out, even though other bloggers don’t seem to have this problem.
Hence, reluctantly, I am turning off the comment function on my blog site. I am sorry about this. Most of my posts will be carried by RGE Monitor, SeekingAlpha or the BCSIA site (though with a delay). Readers may post comments there.