Arnold Kling  

Temporary vs. Permanent

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Tyler Cowen weighs in on an issue that has been bouncing around the blogosphere.

Overall the Keynesian effects can mean either the permanent or the temporary spending boost has a bigger effect and there are also a number of ways of defining what a "bigger effect" might mean.

I assume that when a household gets a check from the government--either a tax rebate or a spending payment--the household assumes that someone else is paying for it. That is, I break Ricardian equivalence.

However, bondholders are forward-looking, so that a permanent increase in spending raises interest rates by more than a temporary increase. If you announce a spending increase or tax cut that will take place in five years, the immediate effect is contractionary, because interest rates go up now but nobody has the spending in hand.

I assume that tax cuts that show up as people fill out their 1040's are perceived as permanent, while tax cuts that show up as "Watch your mailbox for your rebate, and don't forget to vote for the incumbent in November," are perceived as temporary.

Under these assumptions, the greatest stimulus comes from immediate, temporary spending increases and tax cuts that are not marketed as one-time rebates.

And, yes, we are playing this game by Keynesian rules.

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COMMENTS (4 to date)
MattYoung writes:

Double check your last sentence, is there an error?

Anyway, another case. If the government announced a temporary spending pulse some four years prior to the spending, then we get Ricardo, right? If so, then the key is ex-post vs ex-ante, that is unexpected vs expected; not necessarily the shape of the pulse (pulse or step function).

El Presidente writes:


For the most part I agree. As usual, we differ at least a little.

I assume that when a household gets a check from the government--either a tax rebate or a spending payment--the household assumes that someone else is paying for it.

That may not be a reliable assumption. Would it seem better to you to assume:

1. they have no way of knowing who will pay for it;

2. they suspect they will pay for some of it;

3. they cannot be certain how much more they will owe (they don't even know what they owe now); and

4. they seem to have no choice in the matter?

I think it might be as simple as a difference in MPS and MPC based on their incomes and their ability to delay spending in hopes of maximizing return. Greater need and lower liquidity means a shorter time horizon for finiancial decisions. It's not that people think it's free money. They know it isn't, but they are all too aware of their present need and their gloomy prospects. Those with stronger need (less wealth and lower income) will have a higher MPC. Their demand will drive profits, which will drive investment. That's the best way out of these woods.

The reality of who pays for the tax break can be affected after the fact through future fiscal decisions. The next argument that we're likely to hear from the right and the wealthy is that they need a big piece of the pie to get the ball rolling again, and then that it would be unjust and foolish for us to increase their ETR to repay the debt because they would be "forced" to cut back employment and forgo investment.

The uncertainty over the future distrubution of tax burdens will foster an appetite for tax shelters, loopholes, offshoring and other means of sheltering and hiding both income and wealth. In order to make this stick, we need a simplified code, a broader base, appropriate marginal rates, and tough enforcement, because the game won't stop once things start looking up. Somebody in government is going to need to grow a pair and drive a hard but fair bargain.

Thomas Jackson writes:

I didn't realize economists rationalize the schemes of snakeoil salesmen in this manner. Most people are familiar with such schemes if they have encountered a game of three card monte.

There will be no stimulus if the government doesn't clarify the rules and instead changes them with each breeze. Every dollar the government spends is either withdrawn ffrom the private sector or created via printing presses. Either way the economy suffers.

I for one loved disco and studio 54 and it looks as if the economic glories of the 70s are going to be visited upon the sheeple with a vengenace.
So when we face high inflation and high unemployment I don't think too many people will ask how we got here in a few years. Just as Nixon started the glorious 70s the recession lasted a decade. It took Reagan 18 gut turning months to end a decade of mismanagement by centralized government fans.

Hope, change, centralized planning.

hacs writes:

So, if John, a simple household today, who thinks that someone else is paying for a check he received from the government, buy a bond (from some company) tomorrow, then he will change his opinion about that check. It is a state of the human nature.

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