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 Advisors
to G.W. Bush) proposes a height tax.
• Optimal tax policy should focus on generating revenue
without create perverse incentives. An income tax creates a
disincentive to work.
• There is a correlation between height and income (the taller
the person the greater the income).
• Placing a tax on height, removes the disincentive to work since
you 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 unemployment
increases or inflation decreases
• During the financial crisis, the levels of unemployment and
inflation warranted a negative interest rate.
• It would encourage spending but who would lend at negative
interest rates?



• “Imagine that the Fed were to announce that, a year from
today, it would pick a digit from zero to 9 out of a hat. All
currency with a serial number ending in that digit would no
longer be legal tender. Suddenly, the expected return to
holding currency would become negative 10 percent. That
move would free the Fed to cut interest rates below zero.
People would be delighted to lend money at negative 3
percent, since losing 3 percent is better than losing 10. ”

Greg Mankiw (4/18/2009, NY Times)
• Realistically we could get negative real interest rates (after
inflation) if we expect an increase in future inflation.
• What would happen to the real cost of borrowing money if we
expect the inflation rate to increase to 5%?


Helicopter Drop
• During a financial crisis (or large recession) consumers cut
spending potentially leading to a dangerous deflationary
period (Great Depression and Japan).
• To prevent deflation, the central bank needs to get money
into the hands of the consumers. Interest rates are set to zero
(liquidity trap) but no one is spending. With deflation there is
a positive return to holding cash.
• “Let us suppose now that one day a helicopter flies over this
community and drops an additional $1000 in bills from the
sky.... Let us suppose further that everyone is convinced that
this 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 inflationary
expectations. A side effect would be a reduction in
government debt.


Blinder and Hubbard

• To the maximum extent possible, fiscal adjustments should
promote economic growth rather than retard it.
• The burden of policy adjustment should be borne
progressively. That means it should ask more sacrifices from
more-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 shored
up
• Increase retirement age
• Means-testing - reduce benefits for high income households.
• Increase payroll cap.
• Medicare and Medicaid:A substantial share of the budget
cuts 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 larger
government, a reformed system would raise the necessary
revenue with less damage to growth.”
• Broaden the base, lower the rates (Corporate and personal
income taxes)
• End majority of tax exemptions
• Selective taxes that propose an externality to society (sin
taxes, perhaps?)


The Council of Economic Advisors

• Ten past chairmen and chairwoman of the Council of
Economic Advisors came together and advised Congress and
the President to strongly consider some of the
recommendations in the Bowles-Simpson Deﬁcit Reduction
Plan.
• Similar to the previous suggestions


Stimulus Possibilities

• Direct government spending and a simpliﬁcation of the tax
code
• Military Spending - Feldstein
• Infrastructure - Stiglitz
• R and D - (many economists)
• Don’t let the phrase shovel ready be a deterrent (the
slowdown will last for a while)


Carbon Tax

• “A majority of the economists said a tax on fossil fuels would
be the most economically sound way to encourage
alternatives. A tax would raise the price of fossil fuels and
make alternatives, which today often are more costly to
produce, 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 United
States was way too low. Pretty much all economists believe
this.”

Steven Levitt


Carbon Tax

• Blinder labels them the miracle cure. Reduce foreign oil
dependence and reduce the income tax burden. Greg Mankiw
maintains a list of economists in support of carbon taxes (the
list is very long)
• Removes government from subsidizing alternative fuels and
let’s the market determine oil alternatives.
• Canada and Australia have passed similar proposals.
• The average fuel eﬃciency for new automobiles sold in the US
has only increased by 5 mpg (car 28 to 33 mpg and light
truck 21 to 25 mpg)


Carbon Tax - Benefits (from Mankiw)

• The environment - would be the most direct and least invasive
policy to address environmental concerns.
• Road congestion - Reduce congestion on streets and highways.
• Regulatory relief - A higher gas tax would accomplish
everything CAFE standards do, but without the adverse side
effects.
• The budget - A $1 per gallon hike in gas tax would bring in
$100 billion a year in government revenue and make a dent in
the looming fiscal gap.
• Economic Stability - A reduced dependence on foreign oil will
minimize 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, the
price of gas to consumers would rise by less than the increase
in the tax. Some of the tax would in effect be paid by Saudi
Arabia and Venezuela.
• Economic growth - Public finance experts have long preached
that consumption taxes are better than income taxes for
long-run economic growth, because income taxes discourage
saving and investment. It would also encourage firms to
devote more R & D spending to the search for gasoline
substitutes.
• National security - Alan Greenspan called for higher gas taxes
recently. “It’s a national security issue,” he said. The gas tax
is an economic policy with positive spillovers to foreign affairs.


Free Trade

• Increases in U.S. exports have accounted for most of our
growth 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 and
retraining programs.
• Promote greater free trade agreements (Colombia, Korea, and
Panama)
• Work with China, don’t place tariﬀs on Chinese goods.


Food Prices


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.

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