Which fiscal policy?

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Allow me to start by selling the pass. OK, so we need to have some form of a fiscal boost. Government has got to spend more than it taxes and thus boost aggregate demand and fund the gap by borrowing. Leave aside whether this is true or not and concentrate instead on the next step. We can increase the deficit either by spending more and keeping taxes where they are or by keeping spending where it is and reducing taxes.

Varied Guardianistas and the like think we should increase spending, usually because they think that increased governmental spending is the cure for all ills. I would prefer the lower taxation route for I of course know that reduced taxation is indeed the cure for all evils. But within the bounds of the current debate, which of us is right depends upon the various multipliers. How much extra GDP do we get in the short term for extra spending against how much extra GDP do we get from a cut in taxation? The usual assumption is that the boost is greater from spending but this probably (OK,  it isn't) true. Firstly, government isn't very good at spending money quickly.

To make a long story short, you cannot juice up a government agency's budget by tens of billions (or in the case of the stimulus package, hundreds of billions) and expect them to be able to process the paperwork to contract it out, much less oversee the projects or even choose them with any kind of hope for success. It's like trying to feed a Pomeranian a 25 lb turkey. It's madness.

That pretty much rules out any infrastructure or other directed spending on projects. They just take too long to get going.

It also seems that the multiplier of spending is, umm, not very impressive. Like, umm, one and a bit. For each pound of spending we get a one pound rise in GDP.

Valerie Ramey has written a paper with the results of her recent work on the question and with a full bibliography of earlier work. Her answer is that consumption and other categories stay about the same when the government spends more. In other words, the increase in GDP is about equal to the increase in govenment spending (for technical reasons, a mulitplier of 1.4 or so-Tim).

However, the tax multiplier is much higher:

By contrast, recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars.

(Worth noting that Christina Romer is such an aggressive tax cutting right winger that she's just been made Obama's head of the Council of Economic Advisors.)

So we should be cutting taxes rather than increasing spending to provide that fiscal boost then. And this holds even more strongly for us in the UK.

Any large-scale fiscal policy impulse must therefore, to be effective quickly, work through transfers to the private sector, either via lower taxes or via higher transfer to households. The key problem here is that under the present circumstances of extreme uncertainty households might just save any increase in their disposable income. How likely is this to happen?  A key factor will be the financial position of households themselves.

Households that depend on credit to finance their consumption will be most affected by the credit crunch and are thus most likely to react to a tax cut by maintaining their consumption. For this type of household, a tax cut (or an increase in expenditure) will be an effective tool to prevent an even sharper drop in consumption.

However, for households that do not depend on credit, the situation is quite different. Households that are saving anyway will probably at present just increase their savings in response to an increase in their disposable income that they know to be temporary.

This implies that the effectiveness of fiscal policy will vary greatly across the EU. Table 1 shows that households are on average net borrowers in only two of the larger member countries – Spain and the UK, unsurprisingly. In these two countries (with the largest housing bubbles) fiscal policy should thus be effective.

OK, OK, I agree, tax cuts aren't really the cure for all evils, they won't eradicate herpes, Simon Cowell or improve the form of the England rugby team. But it does seem to be true that if we do indeed need a fiscal boost we would be best advised to provide such by cutting taxes upon households rather than allowing politicians to splurge our money, ineffectively, upon their pet projects.

The Media's Top 10 Economic Myths of 2008 (No.9)

In truth, the law of supply and demand mostly determines the price of a commodity like oil. The rapidly growing economies of China and India demanded ever-increasing amounts of oil, jacking up prices. When demand contracted because of the economic slowdown and high prices the bubble burst and prices collapsed.

But if the media must have villains, it could have looked to someone who actually does manipulate prices: OPEC. Western oil companies must rely on OPEC nations for much of their product. When OPEC meets and decides to curtail oil production, the price of oil to all those companies – and everyone else – goes up.

The Business & Media Institute found that the networks ran 14 times more stories about oil companies' profits than OPEC profits. Reporters also overlooked the anti-American hostility of some OPEC nations.

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9. Gas at $4-a-gallon, blame the oil companies.

Media myth: Oil companies and CEOs were a favorite media target in 2008, but the monopolistic oil cartel that does manipulate oil prices was rarely scrutinized.

Originally published by the Business & Media Institute

When gas hit 4 bucks a gallon, who got the blame? Not the oil cartels, that's for sure.

When oil prices climbed to more than $100 a barrel, journalists were looking for someone to blame for Americans' "pain at the pump." They called "Big Oil" companies "thieves" and accused them of reaping "excessive profits" driven by "greed." But the networks ignored one of the leading causes of high gas prices – the hostile leaders of the world oil cartel – the Organization of Petroleum Exporting Countries (OPEC).

On NBC's May 15 "Today," host Matt Lauer interviewed ExxonMobil CEO Rex Tillerson. Lauer quizzed Tillerson on oil companies' profit margins and higher gas prices, but Lauer didn't ask Tillerson about other factors that affect the price of gas, like the Lieberman-Warner climate-change bill.

"Most analysts say prices at the pump will get even worse during the summer driving season," Lauer said, "but the oil companies are posting huge profits." He noted that ExxonMobil, made a $10.9-billion profit in the first quarter of 2008, and asked Tillerson a question from "Today" viewer "Elaine in Pennsylvania":

"How can you justify the record profits you're making when people can't afford to put gas in their cars to go to work?"

In response, Tillerson pointed out that Exxon's profits are not large because of high profit margins, but because of high volume. "[W]hen you take our profit of $40 billion [in 2007], that's 10 cents on every dollar of revenue that we generate," he said. "That puts us about in the middle of most Fortune 500 companies, so we're not at the top in terms of profit per revenue; we're not at the bottom." [Click 'read more' to continue]

Film of the Year No. 9

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9. Priceless

Audrey Tautou (of Amelie fame) plays Irene, a beautiful young gold-digger in the South of France. One night – after her elderly boyfriend has fallen asleep – she mistakes the mild-mannered (and penniless) bartender in her hotel for a wealthy man. One thing leads to another, and a very glamorous farce ensues.

Priceless is a lightweight, charming comedy that aspires to be the French Breakfast at Tiffany's and comes pretty close. It won't win any awards, but it's stylish, funny and highly entertaining from start to finish. Sure to cheer you up even in the midst of a grim British winter.

Watch the trailer here

Blog Review 816

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It appears that Melanie Read in The Times has been recommending the return of slavery.

More evidence on where all the tax money goes.

One way of putting this is that the fallout from the Bernie Maddox pyramid will be a $17 billion fiscal boost in the US.

Answering two questions: which came first, the chicken or the egg and, which came first, trade and the division of labour or Homo sapiens?

A list of nice enough countries to live in and a list of not so nice countries to live in.

On why that bailout of Detroit may well not work....even though it's bound to be very expensive.

And finally, what they say and what they really mean.

In praise of a feminist bookshop

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It will sound strange to some that a classical liberal like myself will praise a feminist bookshop's asking for donations so that it might stay open. Strange, however, only to those who don't quite understand what that classical liberalism is all about.

We know it sounds crazy that a small bookstore in Portland could raise this much money in such a short time, however our community of locals, out-of-town family and friends, as well as feminists nationwide have responded in full force to our plea. They are making online donations, swarming through our doors to support the store by doing their shopping and attending events, and by getting the word out to their own communities that we need help. And its working. We've made nearly $7,000 in the five days since we announced our financial crisis. Clearly, In Other Words is an institution that our community will not let go under.

I've no particular thoughts about feminist book shops, small bookstores or Portland come to that. But I do have thoughts on what is the point of our economic and political system, the most important of which is that if you wish to spend your money in feminist bookshops, small bookstores or even Portland then it is entirely your right to do so.

Just as if you decide that you don't actually want to purchase a book from such a store but would like to send them some money anyway, please, feel free.

For what we're aiming for is not maximal profit, maximal production or maximal anything else but utility. That general ragbag of desires that human beings want to fulfil. And if your utility is maximised (or perhaps increased is better) by your paying more for a book than you would elsewhere, but at the benefit to you of supporting some other goal, say, the social benefits to you of knowing that there is indeed still a feminist bookshop in Portland, then I say good luck to you. So with making a donation but not claiming a book.

As long as you extend the same freedoms to me, that I may spend my money where and as I wish then we'll all get along together fabulously.

That's what being a liberal, classical or otherwise, actually means.

The Media's Top 10 Economic Myths of 2008 (No.10)

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10. Capitalism is dead or dying

Media myth: From Michael Moore to CNBC, people wondered about the end of free-market capitalism.

Originally published by the Business & Media Institute

Is free-market capitalism really at death's door? That's what the media have claimed, beginning with Pulitzer-prize winning columnist Steven Pearlstein's obituary for capitalism Aug. 1. Since then, the claim has been repeated in The Washington Post, on CNBC and CNN. Even controversial filmmaker Michael Moore, reacting to the Wall Street bailouts, claimed capitalism was dead on "Larry King Live."

A front-page analysis in the Oct. 10 Washington Post declared that "The worst financial crisis since the Great Depression is claiming another casualty: American-style capitalism."

That story by staff writer Anthony Faiola accurately portrayed the potential government takeover of elements of the financial system as un-capitalistic, but incorrectly blamed capitalism for economic devastation.

"[T]he hands-off brand of capitalism in the United States is now being blamed for the easy credit that sickened the housing market and allowed a freewheeling Wall Street to create a pool of toxic investments that has infected the global financial system," Faiola wrote. His story had no rebuttal from free market economists who say this was not market failure after all. It also claimed that countries have lost respect for the American brand of capitalism in the wake of U.S. financial turmoil.

CNBC also worried Sept. 19 that capitalism "seems to be dead." That was what former Bloomberg South Europe bureau chief Rob Cox told CNBC's "The Call" viewers while talking about taxpayer funded bailouts "I don't know what it means. I don't know how we're going to regulate. I don't know how we're going to legislate going forward but its dead."

But not everyone took such a pessimistic tone. Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, and current senior fellow at the Hudson Institute said "reports of capitalism's death are greatly exaggerated," in an Oct. 16 column.

"Although Washington is using non-market solutions in an attempt to unfreeze the credit markets, they have not succeeded, and are unlikely to be permanent. The next administration, Republican or Democratic, might take over more of the economy," Furchtgott-Roth said. "But if one country in our global economy proceeds down an unsuccessful socialist road, others will demonstrate the effectiveness of capitalist measures—just as America led the way with tax cuts in the 1980s."

Film of the Year No. 10

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10. Charlie Wilson's War

Set in the early 1980s, and based on a true story, Charlie Wilson's War stars Tom Hanks as the eponymous Texas congressman – a fun-loving, hard-drinking, womanizer (Cinesmith's kind of politician, in other words), who uses his membership of several key committees to covertly fund Afghan rebels fighting against the Soviets.

The film succeeds in being very amusing, and in making its political point – not surprising given that it was written by West Wing creator, Aaron Sorkin. But while Charlie Wilson's War manages to keep the sharp dialogue and tight plotting of Sorkin's TV work, it never falls prey to the preachiness that characterized The West Wing in its lesser moments. Credit for that is probably due to director Mike Nichols, the man behind classics like The Graduate, and top political satire Primary Colours.

Tom Hanks gets excellent support from Philip Seymour Hoffman, as a CIA analyst with 'anger management issues', while Julia Roberts supplies some additional star-power. If only working in politics was really so glamorous. Watch the trailer here.
 

Blog Review 815

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"I Pencil" turns 50 years old this month. It remains, for the layman, the best explanation of how and why markets work. Worth spreading the word about it.

To a rather more complicated question. How much is climate change likely to cost us and how much should be willing to pay to make sure that it doesn't?

Benford's Law strikes again! Bernie Maddox's investment returns breached the law.

Which is more truthful? That the Maddox strategy was symptomatic of the private investment business or more so of the entire public sector?

A truly excellent idea. Paying banking bonuses in illiquid sub-prime mortgage securities.

Something that various greens (and Greens) could learn from an environmental economist. Yes, those green collar jobs are a cost of such schemes, not a benefit.

And finally, on how the experience of felling your own Christmas tree can be ruined by British public  information films.

The return of monetarism

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In the early years of the Thatcher administration, monetarism ruled. Taking their cue from the economist Milton Friedman, the government took the view that inflation was caused by too much money being in circulation. The more of something there is, the less value it has, and money is no exception.

But this kind of monetarism fell victim to Goodhart's Law. Various things can be included in the definition of 'money' – notes, coins, instant-withdrawal bank accounts, but maybe short-notice bank accounts and lots of other things too. Whatever sort of money the government tries to control, those clever people in the City come up with some new kind, and things carry on regardless. So the government's anti- inflation policy changed. Instead of trying to limit the supply of money, it turned to trying to limit the demand for it. High interest rates would reduce the demand for loans, people would cut back their expenditures, and prices would be bid back down again.

That's pretty well where we have been for the last twenty years. Milton Friedman didn't like it. He said that trying to control prices by changing interest rates was like trying to control the output of cars from Detroit by changing the price of steel. It has some effect, right enough, but a very crude one, and one that messes up other things too. But now the Federal Reserve has set interest rates at 0%-0.25%. They can't go lower than 0% – that would mean people would actually be paying to have cash in the bank – at least, not for very long. So what's the answer? Well, the problem now is not inflation but deflation, so the Fed has let it be known that it's very happy to start printing money again. (It will do it electronically through something called quantitative easing, but it amounts to dropping dollar bills from helicopters across the US economy, in the hope that folk will rush out and spend, and prices will turn up again.)

So Milton Friedman, and monetarism, are back. It's a funny old world.

Protecting the Big Three

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Amidst the current financial turmoil, at least one of the Big Three could be on the brink of extinction. Their cries for help have registered in Washington. Yesterday the Bush administration confirmed a deal to provide $17.4bn (£11.6bn) in loans to GM, Chrysler and Ford. This will exacerbate a problem that has deeper roots.

Time and again, the U.S government has sought to provide help to U.S. industries, but this has proven to be at their expense. In 1981, Reagan made it clear to Japanese officials that they should accept ‘voluntary’ import quotas or face having harsher restrictions imposed on them by the U.S. Senate. As the Heritage Foundation argued back in 1985, protectionism allowed the car makers to raise prices without losing business to foreign competitors. It is estimated that the excess cost to the U.S. consumer as a result of this protectionist policy was $3.2 billion in 1984.

The results of such policies can now be clearly seen. Protectionism has jeopardized the industry’s very survival. To overcome the trade barriers, Japanese carmakers began opening production plants in the U.S. and hiring highly skilled U.S. workers. Their focus continued to be on market forces, wages and benefits and innovation as they invested heavily in developing and sustaining the production of fuel-efficient vehicles. At the same time U.S. automakers put innovation on hold, as they required a constant flow of cash to meet their high operating costs. The cloak of protectionism essentially hindered these companies from making the difficult decisions that would have allowed them to remain competitive. The current financial situation has merely acted to bring their ineptitude to the forefront.

What governments have failed to realize is that the economic system exists to serve the needs of the consumer. By propping up failure through various policies, governments fail to understand that consumers are at the very heart of this economic system. Government actions are essentially seeking to limit the choices consumers can make.