Paradox of Thrift

[drz-400]

Interesting article I found on Paul Krugman's blog. It is written by Gauti Eggertsson from the New York Federal Reserve. He is calling our current economic situation, with zero-bound interest rates, a paradox of thrift. He says because of these zero-bound interest rates that certain policies by the government may have adverse effects on the economy. Here is the abstract:

Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures. Another example is a cut in capital taxes. This tax cut deepens a recession because it encourages people to save instead of spend at a time when more spending is needed. Fiscal policies aimed directly at stimulating aggregate demand work better. These policies include 1) a temporary increase in government spending; and 2) tax cuts aimed directly at stimulating aggregate demand rather than aggregate supply, such as an investment tax credit or a cut in sales taxes. The results are specific to an environment in which the interest rate is close to zero, as observed in large parts of the world today.

http://www.newyorkfed.org/research/staff_reports/sr402.pdf

I'll be honest, I have no idea what all the graphs and equations mean, but I found the papers intro and conclusion are readable.

I thought it was interest though, that his model did show a very large government spending multiplier, as opposed to a negative labor tax multiplier during times with a zero interest rate.

I also found his proposal for a national sales tax holiday interesting, although I am skeptical of what the actual results may be, as I would probobly not go rushing out the door to buy something just because the sales tax was gone for a day.

However, an increase in investment tax credits, such as for green energy, stock market investments, and so on seem like a great idea to me though.

 

[Real Korimyr #9]

Everyone says the solution to a flagging economy is to cut taxes, but they all want to cut the wrong taxes-- or worse, they advocate replacing all of our taxes with a sales tax.