Scott Sumner  

Yes, falling oil prices were like a tax cut

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In late 2014, many pundits claimed that falling oil prices were like a tax cut---in the sense that they put more dollars in the pockets of consumers. Note that they were referring to the demand-side effects, drawing a comparison to programs like George Bush's tax rebate program of 2008.

Over at TheMoneyIllusion I did a brief post pointing out that the recent oil price decline doesn't seem to have helped the US economy, where growth slowed at about the same time. In the short run, growth depends more on monetary policy, i.e. NGDP growth.

Here I'd like to point out that tax cuts also fail to boost the economy, unless they affect the supply-side of the economy---say though lower marginal tax rates on work, savings and investment. So those that compared the oil price plunge to a lump sum tax cut were right, but drew the wrong implications from this fact. Bush's tax cut did not help the economy because NGDP growth is driven by monetary policy, and the effects were fully offset by increasingly tight money during 2008. And note that we were not at the zero bound at that time, so that excuse doesn't apply. It was a perfect example of monetary offset. Neither oil price declines nor tax cuts have any necessary impact on output (although one can certainly construct scenarios where they do---it depends why oil prices decline and how taxes are cut.)

The Economist magazine recently discussed a series of academic studies that document how government spending tends to increase right before elections. It turns out that this fiscal stimulus has no significant impact on economic growth:

But this largesse does not appear to achieve much. Election spending, it seems, rarely stokes economic growth as intended. A new paper from Brandice Canes-Wrone and Christian Ponce de Leon, both of Princeton University, looks at 16 rich countries and 56 developing democracies from 1975 to 2012. The authors find that in neither group is the period before an election associated with higher growth, despite more lavish government spending.

There are several possible explanations. It may be that canny voters are saving their fiscal windfall in anticipation of austerity in the future, leaving overall output unchanged. Or it may be that another component of GDP besides government and consumer spending--investment--holds the answer.


There's really no need to search for explanations, as demand-side fiscal stimulus would also raise the rate of inflation, if effective. Obviously a central bank that is targeting inflation won't allow that, and hence will offset the effect. Indeed this was the standard view in macro as recently as 2007, and then seemed to have been forgotten.


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COMMENTS (6 to date)
marcus nunes writes:

Scott, I fact, “too much government can be bad for the economy´s health”!
https://thefaintofheart.wordpress.com/2012/01/31/the-austerity-debate/

Andujar Cedeno writes:

I read a statement like "growth depends more on monetary policy" and I want to see the jobs producing a good or service created by the person making the statement.

Growth depends on the production of goods and services!

Jesse Connell writes:
Election spending, it seems, rarely stokes economic growth as intended.

I think the assumption that economic growth is the primary intention of increased pre-election spending is naive. It doesn't take a big imagination to find another incentive.

Scott Sumner writes:

Marcus, That's right.

Andujar, I should have been more specific--I was talking about the business cycle. Most people agree that neither lump sum tax cuts nor monetary policy can have any role in long term economic growth. I was referring to cyclical recoveries.

Cyril Morong writes:

This might be related

Election uncertainty puts brakes on building sector

http://www.theguardian.com/business/2015/may/05/election-uncertainty-puts-brakes-on-building-sector

Cyril Morong writes:

A study of 90 elections in 27 countries found that real GDP increased in 77% of the election years but only 46% of the non-election years (I found that in a textbook in the early 1990s and I no longer have it).
 
In the U.S. from 1981-2012, real GDP increased an average of 3.49% in election years. In non-election years, it increased 2.43%.

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