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Monday, October 27, 2008

Kotlikoff and Leamer: We Need a National Fire Sale

Larry Summers says spend money on infrastructure to stimulate the economy, which is my preference as well, at least as one part of a fiscal stimulus package. Laurence Kotlikoff and Ed Leamer have a different idea. They say we should hold a national "fire sale" to stimulate consumption:

Running a National Sale, by Laurence J Kotlikoff and Edward Leamer, Martin Wolf's Forum: The demise of financial titans and the incessant warnings of economic Armageddon have unleashed a tidal wave of asset sales across the globe, eviscerating trillions in personal wealth. ...

The same defensive mentality that allowed the sale of equities at fire sale prices threatens to cause a sharp drop in consumer spending, which accounts for 72 per cent of US GDP. If this happens, the economy will slide into deep recession.

We need to put a halt to self-fulfilling prophecies of doom. The key is realising that recessions are usually consumer cycles, not business cycles. They’re driven by weakening demand first for homes, then for consumer durables, and finally for nondurables and services. As consumers stop spending, businesses stop investing, and the economy “recedes”. ...

[O]ur instinct now is to hoard every dollar for fear it’s our last. If we all do this, firms will find no customers to whom to sell their wares. Thus, collective ... attempts to save can undermine the economy, leaving us with less output and, ultimately, less saving. This is Keynes’ Paradox of Thrift.

To escape the panicked-saving trap, we need to immediately and directly stimulate consumption. Having Uncle Sam send us cheques won’t work. Some 80 cents of every dollar of the stimulus checks we received last spring appears to have been saved, not consumed. ...

A better way to spur consumer spending is for Uncle Sam to run a six-month national sale by having a) state governments suspend their sales taxes and b) the federal government make up the lost state sales revenues. The national sale could be implemented immediately. ...

For states with low or zero sales tax rates, implementing this policy requires making their sales tax rates negative, ie subsidising purchases. Shoppers would see a negative tax on their sales receipts, lowering their outlays. State governments would reimburse businesses ... and, in turn, be reimbursed by the Feds.

States would be free to broaden their sales tax bases to apply the National Sale to all retail sales... To make the policy progressive, states could also reduce sales tax rates by more for goods and services that are disproportionately consumed by the poor. ...

How big should this stimulus be? A 5 per cent national sale extending for six months would cost the Treasury about $250bn. Can the government afford this? Yes...

No plan is perfect... But it will apply economic medicine where it’s most needed – on consumer spending, giving everyone an incentive to spend now and begin again to trust our economy and its institutions.

    Posted by on Monday, October 27, 2008 at 12:33 AM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (65)


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