Permanent income

January 20, 2008 by Tom Armstrong.

Mike writes (in response to yesterday’s “Feel-good economics” post):

Ok, well, what Bartlett fails to mention is that Dubya also pushed through tax cuts in addition to the rebates, and that He wants the tax cuts permanent.

As far as rebates in and of themselves, Bartlett may be right, although I know that I am going to spend my rebate. Just as I did in 2001.

In short, the government having less money in their hands and me having more money in mine is a good thing, no matter how it is done. Bartlett should have credited Dubya with his tax cuts in the column.

Mike:

I agree with you somewhat, but I think Bruce Bartlett’s point is that we must concentrate on permanent changes in the tax code. After all, people tend to respond in the short term to long-term expectations. I, for instance, ran a deficit while I was attending college because my long-term expectation was to secure a relatively high-paying job that would permit me to live a good lifestyle and pay down my college debts. If the rebates plan passes, I too will spend the windfall, but it will not be any spending I would not have done otherwise, because I know this change in my income will only be short term. Imagine winning $10,000 in the lottery. Would you spend it all as if you would be receiving this same amount on an annual basis, or would you spend a fraction of it and save the rest by retiring debt or opening a savings account? I know I’d transfer some of that one-time consumption power to the future.

I can’t agree with you more that the government having less of my money and me having more of it is good, but I’d just like to have it permanently. Thanks for the comment.

Mankiw makes this point:

If some journalist out there talks to a member of the Federal Open Market Committee, here is the question I would ask:

If the economy now gets the fiscal stimulus being proposed (about 1 percent of GDP), does that mean that the Federal Reserve will cut interest rates less than it otherwise would?

My follow-up questions:

If the answer to the first question is No, then ask, Why the heck not? Monetary and fiscal policy are two tools available to increase the aggregate demand for goods and services. The goal here is to prop up demand sufficiently to maintain full employment without causing inflation. If the U.S. government is using fiscal policy more, it should use monetary policy less. If the answer to the first question is Yes, then ask, How much higher will interest rates be kept as a result of the fiscal stimulus? And is it really better to have a fiscal stimulus and higher interest rates than a smaller deficit and lower interest rates?

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