In an op-ed in the Washington Post Jared Bernstein expresses skepticism about the likely effects of the recently enacted tax reform:
The timing of the tax cuts is such that they’re throwing a lot of fiscal stimulus—hundreds of billions in new, deficit spending—at an economy that’s already, on its own, closing in on full employment. Based on the already strong, negative trend in the unemployment rate, and the added stimulus, the unemployment rate could be in the mid-3s by the end of this year (it’s currently 4.1 percent). That’s a jobless rate we haven’t seen since the late 1960s.
As someone who constantly longs for very low unemployment, I welcome this development, should it come to pass. The tax cut is very poorly targeted; if I wanted to use the tax code to help those who’ve been left behind, I wouldn’t cut the estate tax. I’d significantly increase tax credits for low-income workers. But the Republicans, because they don’t care about the deficit when it comes to tax cuts, are engaging in an experiment that the more fiscally responsible Democrats would be unlikely to undertake: aggressive deficit spending at low unemployment.
How unusual is that? Well, looking at data back to the late 1940s, the average deficit-to-GDP ratio when unemployment was below 5 percent was close to zero. Since 1980, that same calculation yields an average deficit-to-GDP ratio of 0.5 percent. As I mentioned, the jobless rate this year may average less than 4 percent while the deficit-to-GDP ratio could be about the same, and closer to 5 percent next year. So, pretty unusual.
“Say’s Law” is a rule of thumb in economics that over time aggregate product necessarily creates aggregate demand and it underpins the reform. Dr. Bernstein’s op-ed is suffused with Keynesianism—the view that shortfalls in aggregate demand may persist and can be offset using deficit-driven fiscal stimulus.
My own view is that we’re engaging in fiscal stimulus in the absence of high unemployment but also in the absence of a shortfall in aggregate demand. If the tax reform causes an increase in business investment, it will be beneficial. If, on the other hand, the money is saved, retained in the form of cash or cash equivalents which include things like Treasuries, it won’t have much effect at all.
I believe that nowadays it’s very difficult to predict the results of fiscal policy because of globalization. The title I’d originally thought of for this post was “Stimulus in One Country”. I think that it’s quite possible that consumption effects of the tax reform might be to stimulate the Chinese economy.