ffw 2011

US Economy Crazy Economic Suggestions More Serious Economic Suggestions

What If Politicians Listened to Economists

Ryan W. Herzog

Gonzaga University

October 24, 2011


US Economy

Crazy Economic Suggestions

More Serious Economic Suggestions


Current Output

Figure: Gross Domestic Product and Potential Output


Unemployment

Figure: Unemployment and Employment to Population


Inflation and Interest Rates

Figure: Inflation and Interest Rates


How Economists Think

Figure: Incentives Matter


The Height Tax

• Should we replace the income tax with a height tax?

• Greg Mankiw (chairman of the Council of Economic Advisorsto G.W. Bush) proposes a height tax.

• Optimal tax policy should focus on generating revenuewithout create perverse incentives. An income tax creates adisincentive to work.

• There is a correlation between height and income (the tallerthe person the greater the income).

• Placing a tax on height, removes the disincentive to work sinceyou pay the tax regardless of the number of hours worked.


Negative Interest Rates

Figure: Setting a Negative Interest Rate



• The Federal Reserve will lower interest rates if unemploymentincreases or inflation decreases

• During the financial crisis, the levels of unemployment andinflation warranted a negative interest rate.

• It would encourage spending but who would lend at negativeinterest rates?



• “Imagine that the Fed were to announce that, a year fromtoday, it would pick a digit from zero to 9 out of a hat. Allcurrency with a serial number ending in that digit would nolonger be legal tender. Suddenly, the expected return toholding currency would become negative 10 percent. Thatmove would free the Fed to cut interest rates below zero.People would be delighted to lend money at negative 3percent, since losing 3 percent is better than losing 10. ”

Greg Mankiw (4/18/2009, NY Times)

• Realistically we could get negative real interest rates (afterinflation) if we expect an increase in future inflation.

• What would happen to the real cost of borrowing money if weexpect the inflation rate to increase to 5%?


Helicopter Drop

• During a financial crisis (or large recession) consumers cutspending potentially leading to a dangerous deflationaryperiod (Great Depression and Japan).

• To prevent deflation, the central bank needs to get moneyinto the hands of the consumers. Interest rates are set to zero(liquidity trap) but no one is spending. With deflation there isa positive return to holding cash.

• “Let us suppose now that one day a helicopter flies over thiscommunity and drops an additional $1000 in bills from thesky.... Let us suppose further that everyone is convinced thatthis is a unique event which will never be repeated.”

Milton Friedman (1969, The Optimum Quantity of Money)

• The goal is to increase spending and raise inflationaryexpectations. A side effect would be a reduction ingovernment debt.


Blinder and Hubbard

• To the maximum extent possible, fiscal adjustments shouldpromote economic growth rather than retard it.

• The burden of policy adjustment should be borneprogressively. That means it should ask more sacrifices frommore-well-off households than from less-well-off households.

• The fiscal adjustment should be gradual.


Blinder and Hubbard

• Social Security: The program’s finances need to be shoredup

• Increase retirement age• Means-testing - reduce benefits for high income households.• Increase payroll cap.

• Medicare and Medicaid:A substantial share of the budgetcuts must come out of Medicare and Medicaid.

• Greater means-testing in Medicare.• Increase in co-payment.• Payment advisory board.• Tax health care benefits


Tax Reform

• “Tax reform can enhance growth. And if voters want a largergovernment, a reformed system would raise the necessaryrevenue with less damage to growth.”

• Broaden the base, lower the rates (Corporate and personalincome taxes)

• End majority of tax exemptions

• Selective taxes that propose an externality to society (sintaxes, perhaps?)


The Council of Economic Advisors

• Ten past chairmen and chairwoman of the Council ofEconomic Advisors came together and advised Congress andthe President to strongly consider some of therecommendations in the Bowles-Simpson Deficit ReductionPlan.

• Similar to the previous suggestions


Stimulus Possibilities

• Direct government spending and a simplification of the taxcode

• Military Spending - Feldstein

• Infrastructure - Stiglitz

• R and D - (many economists)

• Don’t let the phrase shovel ready be a deterrent (theslowdown will last for a while)


Carbon Tax

• “A majority of the economists said a tax on fossil fuels wouldbe the most economically sound way to encouragealternatives. A tax would raise the price of fossil fuels andmake alternatives, which today often are more costly toproduce, more competitive in the consumer market.”

Wall Street Journal (2/9/2007)

• “For a long time I have felt the price of gasoline in the UnitedStates was way too low. Pretty much all economists believethis.”

Steven Levitt


Carbon Tax

• Blinder labels them the miracle cure. Reduce foreign oildependence and reduce the income tax burden. Greg Mankiwmaintains a list of economists in support of carbon taxes (thelist is very long)

• Removes government from subsidizing alternative fuels andlet’s the market determine oil alternatives.

• Canada and Australia have passed similar proposals.

• The average fuel efficiency for new automobiles sold in the UShas only increased by 5 mpg (car 28 to 33 mpg and lighttruck 21 to 25 mpg)


Carbon Tax - Benefits (from Mankiw)

• The environment - would be the most direct and least invasivepolicy to address environmental concerns.

• Road congestion - Reduce congestion on streets and highways.

• Regulatory relief - A higher gas tax would accomplisheverything CAFE standards do, but without the adverse sideeffects.

• The budget - A $1 per gallon hike in gas tax would bring in$100 billion a year in government revenue and make a dent inthe looming fiscal gap.

• Economic Stability - A reduced dependence on foreign oil willminimize the impact of oil shocks.


Carbon Tax - Benefits (from Mankiw)

• Tax incidence - A higher gas tax discouraged oil consumption,the price of oil would fall in world markets. As a result, theprice of gas to consumers would rise by less than the increasein the tax. Some of the tax would in effect be paid by SaudiArabia and Venezuela.

• Economic growth - Public finance experts have long preachedthat consumption taxes are better than income taxes forlong-run economic growth, because income taxes discouragesaving and investment. It would also encourage firms todevote more R & D spending to the search for gasolinesubstitutes.

• National security - Alan Greenspan called for higher gas taxesrecently. “It’s a national security issue,” he said. The gas taxis an economic policy with positive spillovers to foreign affairs.


Free Trade

• Increases in U.S. exports have accounted for most of ourgrowth since 2007 ($500 billion)

• Remove barriers to trade (85% of economists)

• For those workers that are displaced due to trade nearly 60%of economists support increased unemployment benefits andretraining programs.

• Promote greater free trade agreements (Colombia, Korea, andPanama)

• Work with China, don’t place tariffs on Chinese goods.


Food Prices

Figure: What’s Wrong With This Picture?


Farm subsidies

• Farm subsidies have lead to an overproduction of certain crops(mainly corn).

• Artificially lowered the price of beverages that use corn syrup.

• This will promote healthier eating.

ffw 2011

Business