9/11/2007

The Way to Prevent the Looming Recession

Recently, the Fed has been in a crises with the current market situation. The Fed is expected to do something about the possible recession as a result of factors such as the housing market. In this article, Robert Reich claims that tax cuts are the answer to the preventing the recession and not the Fed cutting the the federal rate. With major concerns in the economy right now and many homeowners trying to sell their homes without much success, the nation is experiencing rapid loss in jobs in the mortgage, contractor, and many other related industries. Foreclosures are also at an all-time high.

I agree with the article, in that the Fed is not going to be able to turn around the market; however, I don't agree that tax cuts for the middle and lower classes is the answer to avoiding a recession. Doesn't there have to be more than just tax cuts to turn around the economy in a major crises? What else could be done to prevent a recession? With middle-class and lower-class Americans struggling to survive, I don't believe tax cuts will be sufficient because many people in these classes are too high in debt and will not spend the extra money from the tax cuts on other goods to prevent a recession. Also, I believe the article contradicts itself in saying that the middle-class will spend more with a tax cut because it also says that Americans are "so far in debt." With mortgage debt a huge part of the possible recession, payroll tax cuts wouldn't put much of a dent into the outstanding mortgage debt of Americans. Plain and simply put, many Americans purchased homes and expected to be able to get instant equity out of the home and turn it for a profit quickly. As a result, many Americans paid top-dollar for homes and are now stuck with the debt, which they can't afford. Is a recession inevitable?

9 comments:

Dr. Tufte said...

-1 on Hayden for a spelling error (waived).

Recession is never inevitable. On the other hand, it is never clear when one is starting, so it pays to act like one might be.

Reich raises an interesting point. Reich is a real Keynesian.

His point that cutting interest rates won't help is called a liquidity trap, and is a pretty standard Keynesian idea, although one that hasn't shown up much in practice (and for which there isn't much evidence this time around either).

Cutting taxes is a standard, although secondary, Keynesian prescription, and a reasonable alternative. However, Reich advocates exempting the first $15K. This amounts to giving every filer a lump sum check for $1,500. This is close to identical to the part of the "Bush tax cuts" that you get to take off on the back of your 1040. It worked once, so there isn't any reason to be against it.

What's interesting is that cutting taxes is secondary to Keynesians, who tend to prefer increasing government spending instead. The theory is that you can never be sure if a tax cut will be spent, but you can be positive that spending is spent. A more Keynesian prescription then might be to pay everyone's mortgage next month. Most people would reject that because it sounds silly and profligate. This just means that perhaps we ought to think about other policy prescriptions in the same way.

Timothy said...

I disagree with Hayden that the tax cuts won't help to stop a looming recession. By allowing the average American worker more money after Uncle Sam is done helping himself, they will be able to put more of their discretionary income into paying off those debts and adding more money to the economy when they purchase items with the remainder, which us Americans do very well these days. I think it would be a positive thing.

Dominic said...

I think that a tax cut would increase spending, but would only slow down the recession. As Timothy hinted, Americans are very good at spending everything they have and a little more. If you give them a little extra from taxes, they will spend it. However, many Americans are in way over their heads in mortgage and credit card debts. I would like to hear Dr. Tufte’s suggestion as to how a recession can be avoided. It seems to me that a recession full of foreclosures is the most logical way for the market to adjust itself.

Dr. Tufte said...

As a macroeconomist, I don't think "recesssion can be avoided" at all.

I'm not even sure that this is a realistic possibility. The economy did slow from last summer through this spring, and now it seems to be bouncing back. To me, this suggests that the onset of a recession was narrowly avoided 15-18 months ago.

Moreover, I think we have a fantastically strong economy, with low unemployment, low inflation, and growth that seems to be back in good territory. I think this is a time to sit back and do nothing at all.

Wyatt said...

I am a fan of tax cuts. As Dr. Tufte said, tax cuts worked last time so why won't they work again? They also give me more money to spend. I think there is enough evidence from the past to give tax cuts another chance to "save" the economy from recession.

Hailey said...

I agree with Dr. Tufte's statement about letting this play out on its own. While I think it is sad that many Americans made these terrible loans, I think that a recession, or at least a slow down, will be good for our economy right now. The American people have had many years of prosperity and I think that a small check would be in order to bring people back to reality. There will be some businesses that fall apart and some houses that may be foreclosed on, but this a great way to clean out inefficient and unproductive businesses in the market.

Sophie said...

There are definitely things that the Feds could do to slow down and to eliminate a recession. The hard part about this is that there are multiple methods that the Feds could use in order to accomplish this task. It is hard to determine what method will work best in this particular situation though. For right now the Feds are trying to stop this recession by lowering the federal rate, but if this proves to be unsuccessful the Feds will try something else.

Jordan said...

Dr. Tufte said:

"As a macroeconomist, I don't think 'recesssion can be avoided' at all."

I think that recessions generally can't be avoided. Recession is part of the normal economic cycle. While it is preferable to try and smooth out the dips, recessions will happen.

AMIT said...

Good article post written on this topic.

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