Asymmetrical Information

From the desk of Mindles H. Dreck:

Amazing Disappearing Money

In an otherwise sound comment about the partisan nature of the CEA, the New Republic lets slip an interesting comment on tax cuts and the economy:

Now, if the tax cut encouraged consumers to spend more, then, by definition, they must have saved less. To say the tax cut encouraged both spending and saving is nonsensical.

I think this highlights the basic misfiring of synapses in the big-government mind.

Look at it this way. If I get an extra $2 from not paying taxes, and I save $1 and spend $1, consumer spending and savings both increased. I have spent more and saved more. It is the government that is saving less, not I. How is this difficult to understand?

But wait, it gets better! If I spend my entire $2 on Frankwiches, then the Frankwich vendor has my $2. He could save it or spend it.

If I put the $2 in the bank, my bank might lend it to the Frankwich vendor, then he will spend it on Frankwich inventory. His vendor will then bank the money - and it may be loaned to someone else.

So, if a tax cut puts more money in the hands of the private sector, it can be saved and spent several times. In fact, there are only two ways the New Republic can claim any validity to this remark: First, if the consumer is spending a tax cut he didn't receive. While the tax cut bounty is small thus far, that is thankfully not the case. Second, if they mean the overall national savings rate (government and the private sector combined). They don't**. I guess the problem is they're still grieving that the government no longer has this money and it's interfering with basic reasoning skills.

The New Republic "Notebook" is guilty of my ultimate pet peeve - Zero Sum Logic. Yes folks, that's where the blog name came from. It is the ridiculous assumption that a dollar one person has is a whole dollar someone else doesn't have. The right way to look at it is, a dollar one person has is a dollar he might give to you, in a free exchange for something of value.

They are also guilty of what I call the "money in a mattress" assumption. TNR and folks like Paul Krugman like to say that wealthy people save their tax cuts, rather than spend them. This is true, but "savings" are not the same as stuffing them in a mattress.* In fact, if the money is saved, it usually ends up in a bank, bond or stocks. It is invested, which means someone else spends it on labor or goods, creating jobs one way or the other. So it is unclear, at best, whether the rebate spent on non-durable goods by a poorer person has the same or less stimulative value than that invested by a wealthy person. Both find their way into the economy pretty damn fast. Which makes it doubly ironic that we hear so much about our profligacy and need for increased savings from folks who apparently think consumer savings are a one-for-one drag on GDP.

The class wars produce a lot of zero-sum and mattress fallacies. Many of these pundits have become so accustomed to using them they don't realize how glaringly wrong they are.

*This appears to be why Krugman thinks a tax rebate to corporations is a lump sum transfer but somehow a tax rebate to lower income people is pure fiscal stimulus. Jonathan Chait, take notice, there are legitimate questions about Krugman's reasoning.

** National accounts, of course, are governed by the accounting identity Y=C+I+G+X, which dictates, with a little algebraic manipulation that private sector net savings/deficit as a % of GDP plus Government net savings plus net exports (again, as a % of GDP) must =0. So to the extent the private sector deficit as a % of GDP fluctuates, there must be an equal and opposite move in the sum of euivalent measures of the government surplus/deficit and net exports. This is why if the consumer started saving, the government surplus had to disappear (or the dollar could crash..). See Wynne Godley on this, or the third post I made in this blog.

Posted by Mindles H. Dreck at February 28, 2002 10:08 PM | Technorati inbound links