A new paradox - Paul Krugman Blog - NYTimes.com.
This is important, so I hope I'm going to be forgiven for re-posting a loot of it:
Gauti Eggertsson is in the process of presenting a new paper on fiscal policy; the paper is here. In his presentation — though not in the paper — he offers great phrase: the “paradox of toil.”
According to his paper, when you’re in the liquidity trap, certain kinds of tax cuts have perverse effects. Cutting taxes on capital income, for example, encourages more saving — which is a bad thing, because we’re suffering from the paradox of thrift. In fact, reduced taxes on capital income actually end up reducing investment.
So what’s the paradox of toil? If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment.
All of this only applies in a situation of zero interest rates, which wouldn’t be interesting except that that’s the situation we’re in.
The general point is that we’re really through the looking glass, in a world in which lots of things have perverse effects — and basing your policy ideas on intuition from “normal” times can lead you very much astray.
Conservatives please note.
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Richard, below you wrote about Paul Samuelson: “But he was still a neo-classicist – and that branch of economics needs to be consigned to history” – you are aware that this paper by Eggertsson is as neoclassical as you can get?
How do you live with such incoherence?
@Luis Enrique
Incoherence? None at all
Sometimes a neoclassicist will get things right
So what? Overall their direction of travel because of the assumption of rational human beings and stable equilibria is wrong
And I attack them from the big picture perspective
If you’re small minded – that’s your problem
And explains why you’re a libertarian. It goes with the patch
The most obvious fiscal response to the ridiculous situation much of the world finds itself in is to reduce (or ideally eliminate) taxes on production, investment and transactions – Income Tax, VAT, Sales Tax, Corporation Tax, Stamp duties. The balance to be made up by direct collection of unearned economic rents – on banks’ credit money creation, economic rent of land (through Land Value Taxation), fuel rents (through Carbon Taxation). This way, everywhere can be a tax haven!
Another obvious response is to cease government indebtedness to bankers by buying back bonds with government-issued money as economists like Irving Fisher have been calling for for centuries. The money supply should be democratised through direct, per-capita issue to citizens and legal residents by means of a Citizens’ Income. The state should also permit privately issued moneys without hindrance (gold, silver coins, bills of exchange, tally sticks, LETS, WIR, Digital Coin).
The effect of all this is dramatic cuts in the workforce at banks, tax advisers, government (HMRC). These are the cuts needed to bring in a new era of high productivity.
Gauti’s paper seems to be predicated on basic axioms about the money supply and taxation which are simply false. But coming from the NY Fed, at the heart of the private money-creation cartel, what else could he say? Remember, The Cartel has your best interests in mind… Not.
Paradoxes like the above will appear thick and fast if your analysis has to be based on false axioms!