I just very lightly skimmed Greg and Matthew Weinzierl’s paper which seems to be built out of intuition very similar to mine.

A few quick comments

This very Keynesian result, however, is overturned once the set of fiscal tools available to policymakers is expanded. Optimal fiscal policy in  this situation is one that tries to replicate the allocation of resources that would be achieved if prices were flexible. An increase in government purchases cannot accomplish that goal: although it can yield the same level of national income, it cannot achieve the same composition of it. We discuss how tax instruments might be used to induce a better allocation of resources. The model suggests that tax policy should aim at increasing the level of investment spending. Something like an investment tax credit comes to mind. In essence, optimal fiscal policy in this situation tries to produce incentives similar to what would be achieved if the central bank were somehow able to reduce interest rates below zero.

This makes a lot of sense in the blackboard framework. When it comes to current American policy there are two concerns I have

  1. Investment tax credits moving swiftly into the territory of industrial policy
  2. The current situation in which investment in E&S seems to be rebounding extraordinarily well but we have a very little investment in structures. Is it realistic to think that in the wake of a housing bubble burst and a collapse in consumer spending that the government is going to subsidize houses and shopping malls? Again politically this seems odd.

I still think that simply arbitraging the public-private spread through broad based tax cuts seem realistic.

Also, I have to look at the internals of the model but it seems natural that cutting the employee portion of payroll taxes is going to do a lot to combat the sticky-wage problem, especially when you combine sticky-wages with a liquidity constraint on some businesses. My look at the data suggest smaller non-corporate entities are still facing liquidity concerns.


A final implication of the baseline model is that the traditional fiscal
policy multiplier may well be a poor tool for evaluating the welfare implications of alternative fiscal policies. It is common in policy circles to judge alternative stabilization ideas using “bang-for-the-buck” calculations. That is, fiscal options are judged according to how many dollars of extra GDP are achieved for each dollar of extra deficit spending. But such calculations ignore the composition of GDP and therefore are potentially misleading as measures of welfare

This is a conclusion I am big on. The way people talked about multipliers always bothered me. Multipliers are a useful concept but it is not like we are “buying GDP” and need to get the best deal.

Suppose that we had massive tax cuts for liquidity constrained households, but we got very little change in GDP.  We have still improved welfare because we are allowing the households to move consumption from the future to today, which is what they want to do but cannot because of breakdowns in financial markets.

Lastly,  the obvious response to this paper is one in which the marginal product of government investment exceeds the marginal product of private investment. The motivation is that government officials are myopic and that voters dislike deficits; two assumptions that don’t seem wildly unrealistic.

In this case the government will suffer from investment that is too low and – I believe – taxes that are too high relative to the optimum.

In the case of recession this problem may be aggravated. This would give the result that “ a crisis is terrible thing to waste”