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A fiscal stimulus proposal (fiscal version on NGDP targeting)

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Whether you abhor DSGE models or not, the data supports that shocks to the economic system are damaging. It’s therefore not surprising that abrupt fiscal stimulus after a recessionary shock doesn’t work that well. However, in my view, fiscal changes should have a far greater impact, and over a shorter period of time than monetary policy changes. So here is a rough working model for a fiscal “Taylor Rule”.

We somehow agree on a ratio of direct government spending to tax changes, let’s say 50:50. Spending changes would be asymmetric and dependent on vulnerability. Effective tax rates and government spending would then be set by a PID algorithm (in a simple example the way any modern home thermostat works) using NGDP (or some ratio of inflation and unemployment).

Say your effective tax rate was 22% and NGDP growth was slowing (lower inflation and higher unemployment). Then your effective tax rate would be reduced by a rule to say 21.5%. Similarly most government spending would adjust, i.e. if NGDP growth was slowing then your NSF grant would be increased by a rule from say $200,000 to $201,000, or your Social Security check would be increased from $2000 to $2200 (note the larger increase for more vulnerable segments).

Note that all these changes would be smooth mathematically and when tuned probably +/- less than 0.5% over a time constant of a year or less. Fiscal policy is the big hammer, but just like controlling the temperature of your house, it makes far more sense to directly adjust heating and cooling based on past data + recent changes (fiscal policy) than through the price of gas and electricity (monetary policy).

So what keeps us from adopting in economics the way a vast majority of the technical world around us is, and has been, controlled for decades?

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Posted by John Daschbach
Posted on 05/05/2016 9:24 PM
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John, Your comment is very similar to what I believe. If I am read your statement correctly you believe we should use tax policy along with monetary policy. I believe as you do that we should use automatic tax policy changes before the Federal Reserve uses monetary policies to guide people’s financial decisions. If you are interested check out this article “Congress Excessively Financialize Our Economy Creating Financial Crisises And More Poverty”
http://www.taxpolicyusa.wordpress.com My question to Cullen was “When & How Did The Seeds Of The Great Depression & Great Recession Get Planted

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Posted by Happyashell
Answered on 05/06/2016 5:40 PM
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    John, Your comment is very similar to what I believe. If I read your statement correctly, you believe we should use tax policy along with monetary policy. I believe that we should use automatic tax policy changes before the Federal Reserve uses monetary policies to guide people’s financial decisions. If you are interested check out this article “Congress Excessively Financialize Our Economy Creating Financial Crisises And More Poverty”
    http://www.taxpolicyusa.wordpress.com My question to Cullen was “When & How Did The Seeds Of The Great Depression & Great Recession Get Planted

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    Posted by Happyashell
    Answered on 05/06/2016 6:15 PM
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      Hi John,

      I’ve proposed something like this before. I call it elastic deficit spending. Basically, the size of the deficit would be even more automated than it is today using a simple rule.

      I obviously think it’s a good idea and we seem to be seeing the idea of more fiscal policy catching on. But it doesn’t look remotely workable with the Congress we have in place….

      – CR

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      Cullen Roche Posted by Cullen Roche
      Answered on 05/07/2016 1:49 PM
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        Term limits.

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        Posted by MachineGhost
        Answered on 05/10/2016 11:14 PM
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          Cullen, et al. I think an important aspect of what I envision (which may be Cullen’s, I can’t tell) is that you make the adjustments in a wide range of spending systems and taxation rates elastic. You don’t have one-time or short term large shocks (some I’ve used are adoption tax credits, increased energy efficiency tax credits, …) you have small data dependent changes to the entire range of taxation and spending programs.

          I’m not sure Monetary policy has any value in this system. “Elastic Fiscal Policy” is sledge hammer, Monetary policy is a tack hammer. But if you distribute the blows from the sledge hammer over the entire economy in a nearly equal way (I would not, for instance, reduce transfers (SS, …) to the lowest income groups if inflation was accelerating) it has to be far more effective.

          There has to be some value in market price discovery, and for this exercise some blend of the 5 yr and 10 yr TIPS vs. normal spreads seems reasonable.

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          Posted by John Daschbach
          Answered on 05/10/2016 11:37 PM