Fiscal stimulus

Money is being thrown at the economy but there is little discussion of what it needs to do. As we are back in a traditional macroeconomics world with the real possibility of a liquidity trap, we know that the money has to encourage expenditure on real stuff. Saving alone will not cut it. That means consumption and investment. Both are currently a problem due to diminished expectations.

So in terms of what the Rudd government is doing how is it stacking up on stimulating the right stuff. The transfer to pensioners does not appear to count. It is mainly to cushion the shock of reduced wealth in our privatised social security world. That means it will go straight back into those savings.

The money given to local governments is better. It has to be spent and spent quickly. It also had to be spent on new stuff that wasn’t budgeted for. Of course, it is hard to perfectly enforce this but this is as closed to forced consumption/investment as you are going to get.

We can also spend money on infrastructure but we have to do that quickly. That is a hard ask and can lead to really expensive bad decisions. Money spent re-tooling for the coming emissions trading scheme may be a better option.

On the tax side, income tax cuts and corporate tax cuts won’t cut it. These will be mostly saved. However, a temporary cut to the GST would be better. Temporary changes to the GST impact on consumption more than saving and in particular on consumption of durables. Durables are precisely the goods whose purchases are being deferred. So it would hit all the right places. Indeed, I suggested the reverse earlier this year when our worry was inflation.

[Update: and that is precisely what the UK has done].

7 thoughts on “Fiscal stimulus”

  1. Another benefit of cutting the GST would be the stimulus all the millions of dollars that would have to be spent re-writing software riddled with hard-coded “10%” calculations.

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  2. Joshua,

    Help me out here. Why would a 1.5% cut in GST for 13 months or whatever it is, bring forward consumption. In theory I understand the point that it’s better than a tax cut because it creates an incentive to spend (because the cut is temporary) but for goodness sake, we’re talking about 1.5%. And if it is going to have an effect, the ‘pull forward’ effect it has will occur in 12 months when the withdrawal of the cut is one month away. The whole thing seems to me like an amazingly expensive way to not stimulate much consumption. Where am I wrong here?

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  3. I agree that the local government splurge should be suitably stimulating. Surely they could also have done the same in tertiary education. Every university is crying out for infrastructure dollars, and could surely spend it pretty much as soon as the cheque is signed.

    Oh, and yes, this is blatant rent-seeking from an academic 🙂

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  4. Joshua,

    I was hoping for a little more than that. The GST covers all sorts of things where consumption is pretty insensitive to a 1.5% cost change. One can think of fiscal policies that give you much more effectiveness in terms of economic activity per dollar spent or foregone. Incremental govt spending is obviously one such though there are limits to what you can do sensibly. You can offer people incentives to do the kinds of things that they could bring forward. Car purchases are like that, as are building new houses – I’d be very surprised if the first home owners grant for new homes doesn’t generate a hell of a lot more activity than the same amount of money spent as a temporary GST cut. So it seems to me to maximise efficiency one has to aim for consumption which will plausibly respond to the changed incentives. Temporary GST cuts seem like a scatter gun to me.

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  5. I doubt any change short of halving the GST rate will make a significant difference to durable goods purchase. Further much of the durable goods are manufactured outside of Australia so its likely to produce only minimal flow-on effects.

    I think measures such as insulating and double glazing low income and pension households will do more. Firstly, its a service and product demand where most of the money stays within the domestic economy. It produces a measurable benefit to cashflow of low income households due to the reduction in energy bills and it goes a long way to reducing the per-capital energy footprint of Australia.

    These types of measures which could extend to solar power and solar water heating would produce a better overall bang for the buck than most other measures. The financial crisis offers the greatest opportunity for getting the economy across the low carbon tipping point.

    Another method would be to extend the popular solar panel rebate which was shut due to over subscription.

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