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July 25, 2011


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chris strange

Tax cuts can also provide a stimulus effect, therefore logically if you increase spending it should be the equivalent effect of removing stimulus from the economy. If this is true then the anti-stimulus effect of tax rises to balance the budget could be greater than the stimulus effect of the increased government spending, and the net result will be to depress the economy. I have read elsewhere that there is research (this PDF was pointed to http://www.economics.harvard.edu/faculty/alesina/files/Large%2Bchanges%2Bin%2Bfiscal%2Bpolicy_October_2009.pdf) which shows says that the tax cutting has a greater effect than spending rising so it could be true that balancing the budget by spending more and taxing more could be bad for economic growth.


> Assume - and this is crucial - that we have unemployed resources. The government then raises both income tax and public spending. Consumer spending would not fall one-for-one as the tax rises, simply because the tax will also reduce our savings; a £10 tax rise might reduce our spending by only £8, with the other £2 being saving that doesn‘t now occur.

This seems wrong to me. Generally speaking, savings are invested, thus they do contribute to aggregate expenditure. It is only when savings are held as currency or bank reserves that spending decreases, because the increased demand for money combined with price level stickiness leads to monetary disequilibrium. But raising taxes won't much alter the demand for money balances; it's better to subsidize investment, expand the money supply directly, or run a budget deficit.


Really interesting.


What about the lost savings? As long as savings were being invested by banks then you're losing out on investment, which is just as important as consumer spending to growth. Though of course there's probably more of a bottleneck in getting the banks to lend in the first place.


@ Jon - on this, Keynes was right. A decision to save does NOT imply a decision to invest. Foregone savings do not therefore mean foregone investment.
I suppose less saving might put up interest rates. But rates are determined by the stock of savings, compared to which the flow is small, so any impact on investment via higher rates is likely to be small.

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