Temporary vs. Permanent
By Arnold Kling
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.