Tuesday, January 8, 2008

Should Fiscal Policy be Used as a Stabilization Tool?

We already know Greg Mankiw's answer to this question. We now know Alex Tabarrok's answer as well: no. His reasons--which are similar to some of the points I raised earlier--are as follows:

"First, the money for any new spending or tax cuts has got to come from somewhere, right? Thus there is usually substantial crowding out of any stimulus.

Second, by the time the new spending or tax cut gets through the political process the economy has moved on and the stimulus is no longer relevant except by accident.

Third, there just isn't that much discretionary spending to play with and even a large increase in spending, say tens of billions, is too small to make much of a difference in a 13 trillion dollar economy.

Fourth, in their desperation to "do something" politicians will often do something foolish. If a spending increase or tax cut isn't worthwhile on its own merits then it's highly unlikely to be worthwhile once we add in the benefits of "stimulus." Thus, it's one thing to argue for extending unemployment benefits as a matter of welfare it's quite another to think that an increase in unemployment benefits will so increase spending as to reduce unemployment! (The implicit view of Larry Summers.)"

Since Greg Mankiw is crafty at naming new clubs (e.g. Pigou Club), maybe he should find a clever name for the "no fiscal policy" club he and Alex are forming. I suspect Larry Summers will not be joining anytime soon.

See this relevant post by Mark Thoma

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