Finking about stimulus

Green Politics

The position of Fraser Nelson and Guido Fawkes on deficits should hearten the left. Tax cuts are stimulative but spending rises even more so.

Keen blog readers will have been following the fascinating debate over deficit-findanced tax cuts between Danny Finkelstein on the one hand, and Fraser Nelson and Guido Fawkes on the other. The left should be heartened by the latter’s position.

Yesterday, Finkelstein, the fiscal hawk, wrote: “If the Tories were now to cut taxes immediately upon on entering office, what would happen? It would, erm, destabilise the economy, wouldn’t it.” Guido responded:

“bond traders understand that a growing economy supports their coupon payments, whereas a flat or contracting economy is a greater sovereign credit risk. A growing economy can afford to finance a budget deficit if necessary. An over-taxed, low to no growth economy can’t. High taxes, and Britain is a high tax economy after 13 years of Gordon, destabilise the foundations of a strong economy, driving enterprise into the ground or overseas.  Guido remembers when this was ideologically core to Conservative thinking, it was when they won elections…

Today, the Fink replies:

“He is forced into that position by his view, cogently and frequently advanced, that tax cuts should always be proposed since they force the state to cut spending.”

But that’s not quite right. Guido does want tax cuts to be offset by spending reductions but, recognising that spending cuts are politically tricky, believes “in the realm of lesser evils” that deficit-financed tax cuts are stimulative. And he’s right – but spending rises are even better.

During the stimulus debate in the US, much was made of Congressional testimony by Mark Zandi, the Chief Economist of Moody’s Economy.com, an independent provider of economic analysis. In this updated report assessing ‘The Impact of the Recovery Act on Economic Growth‘, Zandi outlines the “bang for the buck” from different aspects of the US fiscal stimulus. While some tax cuts delivered increases in GDP beyond the amount pumped back into the economy, it shows that spending increases were the most efficient form of deficit spending.

The key to recovery is growth. Some tax cuts – like the Government’s VAT cuts or Obama’s tax rebates – can play a stimulative role. But as this independent study shows, government spending is the most efficient way to address the low aggregate demand that typifies the current recession.

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33 Responses to “Finking about stimulus”

  1. Ewan Watt

    “David, Psi, Ewan – I’m not suggesting that the best policy would be to tarmac rural Scotland or to fill in holes for that matter, of course not. But there would be a multiplier higher than zero (and probably close to 1 given the raw materials and labour costs). Reading your earlier comment, I think we atually agree on different policies having different multipliers (the reason I reproduced that table). My contention was that, on average, well targeted spending projects will have higher multipliers than tax cuts. As Giles points out, this is particularly true when the savings rate is rising.”

    Will, thanks for replying.

    But what if the money being used is freshly printed by the central bank? That’s where my real concern comes in. If we’re printing money to finance this stimulus, surely this has a negative effect on the multiplier? This is why I’m surprised why people on the left aren’t more fiscal ‘c’onservative. Sure, if you must, spend money – but spend it using real funds.

    I also struggle to see how building a road that nobody’s going to use is a net benefit to the economy.

    Finally, on inflation – would you not agree that given the fall of the pound (in large due to monetising debt, the perilous state of our economy and our deficit as a whole) it is highly unlikely we’re going to be facing inflation in the short term? Look at our trade imbalance.

    Thanks again for your response – always good to know that people actually take the time to read these emails.

  2. Ed Balls Take Note, Obama’s Keynesian Stimulus Has Failed - Guy Fawkes' blog

    […] growth. Will Straw argued, citing research by a “progressive” American economist that spending increases were the most efficient form of deficit spending. The theory can now be tested against the […]

  3. Nick

    Keynes is economic voodoo on a par with homeopathy for the current mess.

    The mess is too much borrowing and spending.

    The cure isn’t more of the same.

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