Austerity Arithmetic
Paul Krugman uses elementary Keynesian Macroeconomics to argue that the austerity demanded by the Troika would reduce the Greek debt to GDP ratio, if at all, only by causing deflation and increased Greek net exports. This means that it would take a very long time (or forever) to reduce the Greek debt to GDP ratio that way.
I add that this is also an argument for achieving primary surpluses through tax increases (as proposed by the Greeks) rather than spending cuts (as demanded by the rest of the Eurogroup).
The reason is that the effect of a tax increase on aggregate demand is multiplied by the marginal propensity to consume which is definitely less than one. Typical guesses are that it is about 1/3.
My comment
Alternative austerity arithmetic. But what if the 1% surplus were achieved by raising taxes not by cutting spending ? I will be extra super back of the envelope crude and assume that the accelerator effect is equal to the marginal propensity to import so the marginal propensity to consume can be calculated as 1/3 from the 1.5 multiplier . So a 1% of GDP increase in taxes would reduce GDP by (1/3)/(1-1/3) = 0.5% and that would reduce tax revenues by the back of Wren-Lewis’s envelope by 1/6 % so to get to 1% primary surplus taxes would have to be increased by 1.2 % causing GDP to promptly decline 0.6% and the debt to GDP ratio to promptly increase by about 1% so one year to get back to the no austerity debt to GDP ratio.
Your Phillips curve says 1.2*0.23 % less inflation so debt to GDP would fall
(1-(1.7*1.2*0.23)) % per year so it would take about 2 years to get back to where Greece would have been, 2< infinity.
But wait, there's less. What if the increased taxes were taxes on high incomes (say profits over 100,000 euros per year). That would have a much smaller effect on demand.
Or how about increasing spending 0.5% of GDP and increasing taxes 1.5%. That gives a primary surplus 1% higher and no effect on aggregate demand.
The point is that Keynesians do not have to insist on deficits. The alleged need to choose either fiscal stimulus or low debt is nonsense or in any case has almost nothing to do with Paleo Keynesian macro and less to do with new Keynesian macro.
You forget that most economists consider raising taxes on high incomes akin to dividing by zero. You aren’t supposed to do it.
It always reminds me of the old riddle: A doctor rushes into the OR and looks at the patient and says, “I can’t operate on this patient. This is my son.”, but the doctor was not the patient’s father. Nowadays it is rather obvious that the doctor is the patient’s mother, but this was considered so unlikely that this riddle, in various forms, appeared in many anthologies.
The doctor can be a woman. We can raise taxes on the wealthy. We just need to change the way people think. Keep up the good work here and in other forums.
Piketty outlines the essentials of dealing with debt burdens , here :
https://t.co/XVRJyYAiW9
“…it consists of three components: inflation, a special tax on private wealth, and debt relief ”
Taxing the oligarchs in Greece won’t be easy , but it has to be done.
If they’re chased offshore , so be it. Good riddance to the parasites. Just don’t come to the U.S. – we’ve got a possibly-fatal infestation already.
Varoufakis is out :
The key point is to tax the wealth of the wealthy. This is easier than taxing high incomes and the stock of wealth is much larger than the flow of income.
The extreme inequality of the distribution of wealth implies that a flat tax on wealth would have relatively little effect on demand (it would involve tossing low income elderly people out of the large houses they have always lived in and is politically impossible). The point is that while it is possible to hide who actually owns something, it is hard to hide that something.
In any case, a once off wealth tax or capital levy has repeatedly been used to deal with debt and/or end hyperinflation by Germany.
http://rjwaldmann.blogspot.it/2015/06/german-history-and-greek-crisis.html
On the mother surgeon, Archie Bunker was asked that riddle on “All in the Family” (I assume kids these days know what I am talking about). My mother proudly interrupted the TV to tell the answer.
That would be my mother Katharine E. S. Waldmann MD .
Robert, increased taxes will do nothing, and limiting to the wealthy will do almost nothing except drain bank reserves (reserves are kinda important in Greece right now). You are right above with Weimar – higher taxes will help fight inflation, but not fix deflation – will make deflation worse.
Greece needs the ability to run deficits to get employment where needed, and if they cannot, then they will simply be mired in misery and high unemployment – period. But hey, they can roll over existing debt at a decent rate. When you consider Greece runs a trade deficit that means they need to run deficits just to offset that. Reducing GDP to get your deficit/debt ratios in line is like cutting off your foot to lose weight.
Don’t mean to come across as snide – but there are really three options for Greece, and most else is band aids to stop a “Monty Python Flesh Wound”:
1) ECB and Euro Union allow countries to run needed deficits to control unemployment
2) Greece leaves and goes back to fiat
3) They keep doing the same dance
#1 is least painful, #2 is painful if not done right, #3 painful
qualification in my post above – tax increases on rich will drain bank reserves to the extent it creates any surplus. Not sure what banks the wealthier class in Greece uses – my guess is not Greek banks right now.
I vote for 2 (Grexit). Rest of Europe will not allow 1.
But also and always, deficits are not the only way to stimulate demand. An increase in government consumption and investment financed by taxes (especially taxes on the rich) would cause higher demand and employment. Fiscal stimulus is possible without increased deficits. It’s just that the Eurocrats are ideologically opposed to increased public spending and just say that stimulus without increased deficits is unacceptable and reducing deficits in a way which doesn’t reduce aggregate demand is unacceptable.
They do not even pretend that their dictates are supported by quantitative economic analysis. They just say that they have the power (as they do so long as Greeks fear the Drachma more than they fear austerity).
What is the argument for the number of significant digits used in these calculations?
One possibility I mentioned somewhere else (I suspect on crooked timber – because I saw someone there suggesting the same thing – and it gives a warm glow inside to think it may have come from me), is that the Greeks could increase VAT and distribute the revenue raised evenly to all citizens (perhaps making a nominal cut in pensions as a sop to the troika). This warms my heart as it starts a national dividend, but more importantly the VAT is asymmetrical in its effect on imports and exports and does something about the trade deficit which is really at the heart of all of the Euro crisis. It is also net redistributive.