Did the Bush tax rebates actually work?
By Scott Sumner
Here’s Matt Yglesias on fiscal stimulus:
What the country needs is a stimulative process that has the bureaucratic properties of monetary policy, but the heft and comprehensibility of fiscal stimulus. If we had a national sales tax like Japan does, letting the Fed set the rate up and down to boost the economy would work. One alternative would be to enact temporary cuts in the payroll tax, and have the Fed fill the resulting gap in the Social Security trust fund with printed money. Another alternative would be to print money and mail it directly to American households. But barring broad Federal Reserve reform, Congress could act on its own. Back in 2008, Nancy Pelosi and George W. Bush teamed up to enact a cash in the mail stimulus program and it was highly effective. And in the winter of 2010, Barack Obama and congressional Republicans agreed on a payroll tax holiday that also boosted the economy.
I’m very dubious of all this. When the payroll tax cut was rescinded at the beginning of 2013, Keynesians predicted that growth would slow—especially since lots of other austerity measures were imposed at the same time. In fact, economic growth (2012:Q4 to 2013:Q4 nearly doubled over the previous 12 months. That was due to monetary offset. The Bush tax cuts were also ineffective, for two reasons. One is the normal “permanent income theory” argument, people mostly save temporary tax changes. Here’s a graph from an article by John Cogan and John Taylor:
Notice that the tax rebates of the spring of 2008 boosted disposable income sharply (but only briefly). Consumption rose only modestly, suggesting that most of the tax cuts were saved. Nonetheless, I’d guess that some borrowing-constrained households spent more, so let’s assume that the faster NGDP growth in 2008:Q2 was due to the rebates:
Annualized NGDP growth:
2008:Q1 – 0.5%
Remember, these are nominal figures, the real numbers for the first three quarters are much worse. My claim is that even if the strong Q2 number is due to the tax rebates, it merely stole growth from later in the year.
Let’s consider the Fed minutes from 2008. They show worry about the high inflation rates of mid-2008 (largely due to oil), and also some complacency that the Fed’s aggressive moves in early 2008 had worked. As late as mid-October, the Q2 figures were the last GDP data available. Even as late as the meeting 2 days after Lehman failed (September 16), the Fed saw risks of inflation and recession as being roughly balanced. Thus they did not cut interest rates (from 2%) at that meeting. Indeed there were no rate cuts at all between the beginning of May and early October. That’s pretty shocking given the severity of the 2008 recession. In retrospect, the Fed was clearly offsetting the growth in spending in Q2, which was produced (perhaps) by tax rebates. It’s a nearly perfect example of monetary offset.
Indeed even an economist as Keynesian as Paul Krugman concedes the Fed steers the economy in normal times, and that fiscal stimulus is only justified when at the zero bound. So my argument here is just as much new Keynesian as market monetarist.
However Yglesias does raise one good point, which calls into question my earlier grudging support for the Japanese national sales tax increases (3% this year, another 2% planned for next year.) Matt says that stocks rose sharply on the news the second increase might be delayed. I’m not sure if that’s why stocks rose, but let’s say it is (did they rise right after Abe’s comment?) In that case, I may be wrong about the sales tax increase. Perhaps it has more of a negative effect on AD than I assumed. Or maybe stocks rose because investors like low tax/smaller government policies (an argument one of my supply-sider commenters tried to sell me on.) It might have also been a subtle signal of more monetary stimulus. That later claim may seem far-fetched, but is testable in principle. Fiscal growth measures strengthen a currency while monetary stimulus weakens it. How did the yen move on the Abe statement?