Milton Friedman on the Stimulus Package
The President is signing the $168 billion economic stimulus package today, in hopes of averting a recession triggered by, among other things, rising mortgage default rates and the concomitant loss of value in mortgage-backed securities. But will this fat package of tax rebates really do the trick? Is it even a good idea? My colleague John Berlau had an excellent take on this back in January:
The market is concerned about inflation and an unstable dollar, as Bernanke basically said [in January] that he will lower interest rates at will. And it is concerned about the tax cuts expiring — in 2011 by law, and possibly sooner depending on things like election results.
This uncertainty constrains investment. And that’s why it would be so much better reduce this uncertainty by an action such as making the tax cut permanent than a Keynsian temporary stimulus that has been show again and again to be flawed. The late Milton Friedman’s “permanent income” hypothesis demonstrably shows that people do not spend money from a one-time stimuli from the government — in fact if they perceive bad times, they are likely to hoard any extra money they get — but with regard to expectations about their future income. (A good summary of his views can be found at this eulogy from the Wall Street Journal editorial page)
That’s why he argued that during a recession, the best thing the government could do was raise income expectations by changing incentives through policies such as permanent tax cuts. As he told Radio Australia in the late ’90s, “Cut taxes in order to increase incentives, but there is no need for the government to increase spending.”
As much as I’m going to enjoy spending my rebate check, I’d also rather see permanent tax cuts.