The TC Rule for Fiscal Policy Screams “Lower Taxes and More Spending!”

There has been a bit of noise around the blogs about fiscal rules. Nick Rowe says we should use fiscal policy, even though he means we should have the CB buy stocks or something like that. Matt Yglesias says we should flat out use fiscal policy. Atrios is getting in on the idea too.

A few of us boldly stepped into that dark abyss in the middle of last year. Fiscal policy shouldn’t be an ad hoc, make it up as you go exercise.

We really need to know just how much fiscal to use. So, I proposed a fiscal spending rule to decide the size of the government budget deficit. There are other excellent ways to create rules for fiscal stimulus as well. Carlos has suggested using the unemployment rate to change the level of payroll taxes.

The TC rule right now says – it screams – “WE NEED MORE SPENDING”. In fact, using reasonable numbers, the U.S. Government Budget Deficit should be 13.8%!

The rule itself is pretty simple. It uses our two biggest concerns of employment and inflation, and sets targets for them. It also accounts for population growth, so we can keep per capita GDP growing. It relates these three things to give an amount of deficit spending required to hit these targets.

Here is the rule:

1.8(Uc – Ut) + (It – Ic) + Pop = % (Gt)

1.8 (Current Unemployment – Unemployment Target) + (Inflation target – Current inflation) + Population Growth = Target % Government Deficit

The 1.8 multiplier comes from the well known relationship between employment and GDP called Okun’s Law.  Unemployment varies by 1.8 times the change in GDP, according to recent regressions. To get unemployment down 1%, GDP needs to increase by 1.8%.

Some people are worried about inflation, and I am a bit too. All things considered, I prefer lower inflation to higher inflation.

I suggest using 4% for an unemployment target.  Why? We’ve hit 4.5% and 4% in the last 20 years, and both times we didn’t have much inflation at all.

The suggested target rate for inflation?  4%    Brad Delong is just one of many people who feel a low inflation rate target is harmful because it keeps the economy close to the Zero lower bound for rates.

For the current inflation rate, annualize the last quarter of data. Inflation is a “noisy” series. We could use the last quarter or core inflation, but for now, lets just use the last three months of CPI

In any case, you’ll be hearing much more about these ideas going forward, but for now, let’s just plug the numbers into the TC rule and see what we get.

1.8 (8.5- 4.5) + (4- (0.5))  +1.2 = 13.8%

We should be running a 12.9% Budget Deficit right now according to the TC rule. The projected deficit for next year is 7%  We’re 6% short of where we need to be to get this economy really moving.

4.5% unemployment isn’t an impossible goal, and 4% inflation – well, the inflation rate was higher for an entire 30 year period in the 60’s, 70’s, and 80’s. (I’d show you a chart from FRED, but the inflation chart won’t show up! I think it’s a conspiracy to understate inflation.)

Comments
  • Delusional Economics February 3, 2012 at 9:34 am

    G’day from Australia.

    A good start to what hopefully becomes a daily staple.

  • JK February 3, 2012 at 11:37 am

    When you are talking about the budget deficit, and you say 12.8%, or 7% etc… of what?

    The budget deficit should be 12.8% of what?

    thanks

    • Michael Sankowski February 3, 2012 at 12:27 pm

      ha! You caught me. % of GDP – I’ll fix that now.

      Also be aware this is an opinion derived from a fiscal rule, a rule loosely based on the ideas of MMR.

      • beowulf February 3, 2012 at 7:20 pm

        GDP (as of Q411) is $15.3T. To approximate then:
        7% is $1.1T (current deficit)
        6% is $900B
        Suspending the rest of 15.3% FICA (ex current 2% FICA holiday) pretty much gets you there, $$850B.

        out of 1.

        • Clonal Antibody February 4, 2012 at 4:36 am

          I would also use targeted unemployment to extend UI – in other words, UI gets extended indefinitely until unemployment hits 1% above the target unemployment.

          Further,the target unemployment should be closer to what is considered structural unemployment. NAIRU used to be 3%, became 4% then 5%, and now is what? I believe that latest numbers are coming close to 7%. So obviously the whole NAIRU methodology and thinking is faulty.

          Again, if your inflation target is 4%, and you say that the last time unemployment was 4.5%, there was little inflation, then I would contend that your target unemployment rate has to be lower – probably down at the 2-3% level.

          • Michael Sankowski February 4, 2012 at 10:25 pm

            This is a great idea! As long as unemployment is “too high”, extend UI. I really like it. It’s not like UI is such good pay anyone willing to work at all would turn down a decent job to stay on UI.

            Then you are 100% correct about NAIRU. This is a bad idea and it’s a bit sad use it. I would agree to put the target U rate at the frictional rate of unemployment. 4% for me was…well close to that frictional rate.

        • Clonal Antibody February 4, 2012 at 4:48 am

          Also, if we take the extension of UI,to the levels I suggested below, that would lead to a deficit of 15.5% of GDP or about an additional $1.25T –The addition UI cost would be an additional $50B. An annual per capita grant to the states of $320B or $1000 per capita would do the trick.

          So as per Beowulf,

          FICA Holiday $850B

          My suggestions
          Continued UI $50B
          Grants to states $350B

          These should have an extremely stimulative effect on the economy.

  • Andrew P February 3, 2012 at 1:59 pm

    Doesn’t it matter (in the medium-longer term) what the deficit spending is spent on? I can’t imagine that doing something totally unproductive, like paying people to dig holes and fill them up again, will produce any long term benefit to the economy, but building useful infrastructure might. Something like a major widening of I-95 and I-40 would make for a very good use of deficit spending. :)

    • Dunce Cap Aficionado February 3, 2012 at 8:25 pm

      Absolutely.

      In fact, if the government spends more than it *should* on something it is creating some inflation by doing so. That’s my understanding at least.

      In this situation I think a lot of people who understand this stuff (I losely include myself in that group) would advocate reduced taxes not increased spending.

      See Beowulf’s comment regarding FICA in the above thread.

      Best

  • Dunce Cap Aficionado February 3, 2012 at 2:34 pm

    Very excited about the site!

    Is Carlos going to be a regular author here?

  • Pierce Inverarity February 3, 2012 at 4:31 pm

    Question: how does the delevering cycle fit in here? There’s still a major domestic private sector debt overhang that will absorb at least some of the multiplicative effects of increasing the deficit, no?

    Can’t wait for this site to get up to full speed!

    • Ben Wolf February 3, 2012 at 11:49 pm

      Well yeah, but as the deleveraging process accelerates more and more consumer spending should become available, and less of the deficit diverted to the banking sector. It seems to me there’s a huge, unquantifiable psychological component here; there’s really no way to know how hard the private sector is going to save or spend in response to macroeconomic policy, is there?

      • Michael Sankowski February 4, 2012 at 10:16 pm

        Good question. I think…it’s a bit outside the scope of a fiscal policy rule.

        It’s only a possible rule we could use to decide spending. Monetary Policy as used today has the same problems and worse.

        Still, it actively targets unemployment and inflation, which should be our best real time observations we have to tell us what level of saving and spending are in the real economy.

  • Noam February 3, 2012 at 5:23 pm

    I don’t understand including population growth. Say a nation has 10% population growth. Should it be running 10% of GDP fiscal deficits while it’s at target inflation and unemployment?! If we remove the population growth component, use 2% current inflation (that appears more likely) and 2% target inflation (higher inflation does not appear desirable for reasons I won’t detail now), your suggested rule would be:

    1.8*(8.3-4.5)+(2-2)=6.8% suggested deficit as a percentage of GDP. Perhaps current fiscal policy isn’t so bad, though policy details — including lack of full employment opportunity at a minimal wage — leave much to be desired.

  • T February 3, 2012 at 6:58 pm

    The design of this site is all over the place. Weird fonts and layout. Sort it out!

    • Michael Sankowski February 4, 2012 at 10:17 pm

      We’ve got a ace in the hole here – my lovely wife the web designer! She’s going to be looking at it in the next week.

  • chewitup February 4, 2012 at 12:43 am

    May the keyboard rise up to meet you.
    May the neolibs be always at your back.
    May the sun shine warm upon your “realism”;
    the hits fall soft upon your website and until we meet again,
    may God hold you in the palm of His hand.

  • Dan Kervick February 4, 2012 at 3:45 am

    Interesting proposal. But isn’t a proposal to decrease taxes and increase spending “politics”? I thought there was supposed to be no politics and only description on this site.

    • Michael Sankowski February 4, 2012 at 10:12 pm

      Hi Dan,

      The front part of the site will deal only with descriptions of the system. We will have articles on Mosler’s ideas and Godley’s work, and a few other interesting and descriptive ideas as well.

      The second side of the site will deal with proposals based on those ideas. This is the active blog which you are reading now.

      Of course, I’ll be mouthing off like crazy on this side, so don’t expect this to be some arid discussion of basic math. Expect some TC takedowns, some Cullen smack-you-in-the-head basic observations on how things must work and cool models using sector balances, some Carlos proposals using ingenuity and his powers of knowing everything ever written, and more.

      Imagine all you’ve seen us do in other places, and you’ll have our starting point. I’m sure we’ll have guests and frequent contributors too.

    • rodney February 5, 2012 at 3:22 am

      We seek only to educate the public on the ways in which the modern monetary system functions. No biases, no politics, just the facts…agreed. the use of fiscal policy is political any way you look at it. This is all theory about fiscal rules and no description.

    • beowulf February 5, 2012 at 7:51 pm

      I refuse to accept your very premise. The govt’s fiscal stance can be tightened with higher taxes (or lower spending) and can be loosened with the reverse pair. Spending and taxation decisions can be progressive or regressive, for example, the USDA spends money on food stamps for the poor and crop subsidies for agribusiness. And there are tax breaks for both child care expenses and for hedge fund carried interest.

      The combination of tax and spending decisions that Congress chooses is the political part, but the need to loosen the fiscal stance (at this point in time) is simple economics. To paraphrase Barack Obama, there is no red state economics or blue state economics, there is only sectoral balance economics.
      :o)

  • hangemhi February 13, 2012 at 4:00 pm

    Is there value in comparing the value of the dollar in the past to that year’s Gov debt?

    Using this link
    http://www.savingsbonds.gov/govt/reports/pd/histdebt/histdebt_histo3.htm

    I find the debt for a given year – like $14.5 Billion in 1918.

    Then using this link
    http://mykindred.com/cloud/TX/Documents/dollar/

    I find the value of the dollar than vs. now – which is $1 today = $2,217 in 1918.

    The result is that in 1918 they had $32.3 trillion in debt.

    I can find lower years, but I can also find much higher years – 1946 is $460 trillion in today’s dollars.

    The commom metric is % of GDP. But what of the above?

    • Michael Sankowski February 14, 2012 at 7:06 am

      I don’t know. I’ll take a look and see. You’re proposing to just compare the ratio of debts over time and you’ll get a rough approximation of the value of the USD. Interesting.