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Sunday, March 23, 2003

Give That Tax Cut a Closer Look

One of the principles of economic (or any other) policy analysis here at Bonobo Land is : look not at what they say, look at what they do. I have started to push this argument hard recently in the context of the declining dollar. Despite denials to the contrary, I remain convinced that US treasury policy is to allow the dollar to slide down, and that when the war is over we will see another wave of dollar selling as this becomes apparent. The objective: to correct the structural problem of the trade deficit, and to ward off any threat of deflation in the US. The practicalities of this seem to be a tacit agreement with the Japanese to allow them to break the rise in the yen, and leave the euro to do the heavy lifting. Policy response to changing economic circumstances in Europe are so slow, that for the time being all the politicians are basking in the sunlight of the euro's new found wealth. This complacency is reinforced by a faulty appreciation of the global economic slowdown as being simply the by-product of geopolitical instability associated with 09/11 and Iraq. Meanwhile across the Atlantic there is no such complacency, and a good deal of strategic thinking. I am convinced Stephen Roach is right: Greenspan, Bernanke et al take the deflation threat seriously and are working to avoid it. The heightened US sensitivity may also be a product of the fact that the United States has one face looking out over Asia, and policy makers are more aware of the extent of the problem. Be that as it may, I fear that euroland may not see the problem till it strikes.

Another topic where I feel the important point is not what people say but what they are doing, is that of the Bush tax cut. Looking at what is happening in Iraq at the present time I feel it is a mistake to underestimate the intelligence of the Bush administration. If you want the world to believe you are crazy and stupid, then what could be better than having a president who is prepared to act as if he were a war-crazed cowboy with sub-normal intelligence. But remember this is theatre. Behind the act there is some hard thinking going on. I therefore suggest that it may be a mistake to become so obsessed with the Bush theatre roadshow as to miss what may, in fact, be important policy changes. Firstly, as I have already indicated, there is the appointment of Greg Mankiw as economic adviser: not the most obvious Bush "Mark 1" style yes-man. (This is obviously coupled with the exit-stage-left of Glenn Hubbard, who, frankly my dear, didn't have a clue). Then we have the notorious tax cut. I don't want to enter into the ins-and-outs of whether this was a responsible policy in the first instance (in all probability it wasn't, but then the reality in which it was formulated has long since disappeared into the past). What interests me more is the way the tax cut can in fact be hijacked and converted into an SPV (special purposes vehicle). The job, right now, of the American president is to convince the markets and the American consumer that there is going to be inflation: this remember is to escape from the zero bound trap. But not inflation right now, since everyone believes that the Fed being the serious entity it is, this would soon be brought back under control. No, what they have to do is convince everyone that there is going to be serious long-term inflation. If I am right, in doing this they hope to avoid short-term deflation (remember we have serious papers knocking around out there with titles like "On the Responsibility of Being Irresponsible"). So what better way to convince everyone that this is going to happen than sell the image of your 'polyvalent loony', the president whose only interest is to keep his rich friends happy, and use it to ram home the point - inflation is on the way. And it seems to be working: Certainly an economist as prestigious as Paul Krugman is convinced there is going to be serious inflation in ten years time, and to put his money where his mouth is he has taken out a fixed rate mortgage. And if Paul Krugman is convinced, then so too are a lot of readers of the NYT, etc etc. What I would like to believe, since I have always respected Krugman as an economic thinker, is that he is as recursively aware of his own part in the theatre as Bush possibly is. Of course, once everyone is suitably convinced, and deflation is avoided (this, of course, on the conventional view of the deflation problem which I personally don't accept!!) then we might find them saying, aha, caught you, only kidding. This would be a much more convincing act than the Svenssen scenario of the sombre central banker (Greenspan?) trying to convince everyone that he's going to be irresponsible, but only for two or three years. No, the vaudeville is much better if the central bank character is seen to come out publicly and criticise the 'irresponsible' president.

Well, I'll leave you all to make up your own minds. But just in case you think it's only me who could think of this, I'll leave you with a quote from the Bank of England paper:

Another policy that has been proposed is to print more money and to transfer it to the private sector. To recap, normal open market operations involve the central bank and the private sector exchanging cash for bonds, making mirror-image changes in the public and private sector portfolio of assets. However, a money transfer
would involve printing money and giving it to the private sector, taking nothing in exchange. If this money were valued by those that received it, they would feel wealthier, and their spending would rise.There are many difficulties that a money transfer of this kind would entail. Literally distributing money among the population in a way that does not impose costs on the economy by affecting the current distribution of income and wealth is likely to be administratively infeasible. One possibility is that money is printed to finance a tax cut, given some level of governmentexpenditure.
Source Bank of England Quarterly Review

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