I have a question for people who know more economics than I do.
Right now, if I understand the state of debate about the Fed, there are two camps.
One camp holds that the Fed can do a variety of things – such as purchasing debt of somewhat longer maturity than T-bills – that are metaphorized as “dropping money from helicopters” in order to reduce the value of money, which should stimulate demand, and help pull us out from what might otherwise be a double-dip recession.
The other camp holds that the Fed really shouldn’t do these sorts of things at all except in a Titanic-scale emergency because of the risk to the ultimate credibility of the currency – that you’ll overshoot the desired outcome of “inflation expectations go up” and go directly to “the Fed’s gone mad – let’s put all our money in gold (or Euros, or whatever looks like a better store of value than dollars that are being dropped from helicopters).”
(Interestingly, Paul Krugman, in his 1998 article on Japan argues that it is only the expectation of precisely this kind of irresponsibility that could possibly make unconventional monetary policy work:
If this stylized analysis bears any resemblance to the real problem facing Japan, the policy implications are radical. Structural reforms that raise the long-run growth rate (or relax non-price credit constraints) might alleviate the problem; so might deficit-financed government spending. But the simplest way out of the slump is to give the economy the inflationary expectations it needs. This means that the central bank must make a credible commitment to engage in what would in other contexts be regarded as irresponsible monetary policy – that is, convince the private sector that it will not reverse its current monetary expansion when prices begin to rise!
Put that in your rotor and smoke it, helicopter Ben.)
In any event, the alternative to action by the Fed is action by the Treasury – increase borrowing and put the money into the economy via either government spending or tax cuts. We all know the political constraints on this kind of action, and I rather think it’s subject to the same kind of criticism – if the Treasury issues a whole bunch of 10-year debt, that should push up the yield on government bonds, which should stimulate more private savings to take advantage of the yields, and that rise in private savings should offset the stimulative effect of the tax cuts, so there isn’t any point. Japan’s public debt has grown positively brobdignagian since the early 1990s, but it’s all financed by domestic savings and has therefore traded off with dwindling private sector demand; hence it’s done precious little to stimulate growth. Again, the only way to make this work is to reduce confidence that the government will pay back the bonds in good coin – in other words, to behave truly irresponsibly.
So now we come to my question.
Our goal is to increase the output of the economy, either increasing aggregate demand for goods and services relative to demand for money (the demand side approach), or encouraging the deployment of “dead” money in productive investment (the supply side approach).
Wouldn’t a meaningful wealth tax do both?
A tax on wealth (financial assets and real property) is functionally equivalent to a rise in inflation (that’s why inflation is also described as a tax on savings). Money currently earning a nominal zero percent per year in a savings account would now earn negative two percent per year because of the tax. Spending on assets that naturally depreciate (cars, toasters, trips to Florida) would look more attractive than watching one’s money evaporate through taxes. So would taking risk on a productive investment that might yield a big return but might go bust – just as when inflation expectations rise people shift out of safe short-term bonds and into riskier assets, to “stay ahead of inflation.”
Take the money from the tax and spend it on public works, or reduce other taxes to offset, or just rebate it. Because the wealth tax persists, there’d be a good reason why people would not just save the rebates – again, to stay ahead of inflation.
It feels to me like if, instead of taxes on wages and income, we had a wealth tax and a value-added tax, you’d have a readily available policy lever for increasing or decreasing the velocity of money as desired. Just raise the wealth tax and cut the VAT whenever we look like we’re dipping towards deflation, and do the opposite whenever inflation rears its ugly head.
What am I missing? Isn’t this a pretty straightforward and “fiscally responsible” way around the “zero bound” problem of manipulating nominal rates?
(Alternatively, as Larry Niven once proposed, we could mint nuclear waste. That would certainly be a disincentive to hoard cash!)