Cutting Taxes Helps Economy More than Increasing Government Spending
I believe the "policy missteps" diagnosis is mainly the right one, but quote some comments on the "secular stagnation" diagnosis because I want to document that for easy access for my book project.
(p. 3) Economists, like physicians, sometimes confront a patient with an obvious problem but no obvious diagnosis. That is precisely the situation we face right now.
. . .
Secular stagnation Lawrence H. Summers, former economic adviser to President Obama, has suggested that the problem predates the recent financial crisis. He points to the long-term decline in inflation-adjusted interest rates as evidence of reduced demand for capital to fund investment projects. He cites several reasons for the change, including lower population growth, lower prices for capital goods and the nature of recent innovations, like the replacement of brick-and-mortar stores with retail websites. The result, he says, is secular stagnation -- a persistent inability of the economy to generate sufficient demand to maintain full employment.
His solution? More government spending on infrastructure, like roads, bridges and airports. If the government takes advantage of lower interest rates to make the right investments in public capital -- admittedly a big if -- the policy would promote employment in the short run as projects are being built and make the economy more productive when they are put into use.
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Policy missteps When Barack Obama took office in 2009, the economy was in the midst of the Great Recession. President Obama's advisers relied on standard Keynesian theory when they proposed a large increase in government spending to energize the economy. The stimulus package was the administration's first economic policy initiative. As the economy recovered, the administration supported tax increases to shrink the budget deficit.
But even at the time, there were reasons to doubt this approach. A 2002 study of United States fiscal policy by the economists Olivier Blanchard and Roberto Perotti found that "both increases in taxes and increases in government spending have a strong negative effect on private investment spending." They noted that this finding is "difficult to reconcile with Keynesian theory."
Consistent with this, a more recent study of international data by the economists Alberto Alesina and Silvia Ardagna found that "fiscal stimuli based on tax cuts are more likely to increase growth than those based on spending increases."
For the full commentary, see:
(Note: ellipses added, bold font in original.)
(Note: the online version of the commentary has the date JUNE 17, 2016.)
A Larry Summers paper on his version of secular stagnation, is:
The Blanchard and Perotti paper mentioned above, is:
Blanchard, Olivier, and Roberto Perotti. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output." The Quarterly Journal of Economics 117, no. 4 (Nov. 2002): 1329-68.
The Alesina and Ardagna paper mentioned above, is:
Alesina, Alberto, and Silvia Ardagna. "Large Changes in Fiscal Policy: Taxes Versus Spending." In Tax Policy and the Economy. Volume 24, edited by Jeffrey R. Brown. Chicago and London: University of Chicago Press; Cambridge, Mass.: National Bureau of Economic Research, 2010, pp. 35-68.