Note: this post replaces a post entitled “Abba Lerner’s interest rate mistake” (15th Dec 2010) because I made a mistake in the latter post (details below). I’ll delete the latter post in due course. The first two sentences of the paper by Stephanie Bell say “In 1943, Abba Lerner composed an article entitled Functional Finance and the Federal Debt.
I basically agree with Lerner’s paper, however, not with a genuine point he makes about interest rates. In the above-mentioned 15th Dec post I thought Lerner was advocating interest adjustments to optimize the quantity of investment: in fact, as the above-mentioned quote makes clear, he advocated such adjustments to control inflation.
Anyway, why do Lerner believe that adjusting rates of interest is desirable as a way of managing inflation when he has just advocated changing government net spending as a method of controlling demand and inflation? See bottom level of his p. Adjusting interest rates almost certainly affects inflation: e.g. if an economy is near inflation and capacity looms, then raising rates of interest will presumably result in a finite reduction in investment spending, which in turn will reduce inflation.
But the important question, which Lerner will not address, is why do we are in need of two tools to do one job? Having two tools doing one job is not really consistent with the Tinbergen principle. If the two tools have apparent and different merits and demerits, there could be an incident for using both then.
For an example of a demerit, interest adjustments are most likely distortionary for the reason that they work only via entities that are significantly reliant on borrowed money. Fiscal policy can respond quickly and needn’t be distortionary. In contrast, changes in authorities’ net spending needn’t be distortionary: e.g. the spending is inspired by a payroll tax change practices of ALL employees, which is a big proportion of the population. The result should be fairly non-distortionary Hence.
The truth that in practice changes in authorities net spending often ARE distortionary and/or remember to put into action is irrelevant. The distortion often occurs because for example politicians lobby for his or her favorite and bizarre bits of pork every time there is certainly money available with which to purchase pork. Nonetheless it would be properly feasible to involve some fiscal changes (e.g. payroll tax adjustments) that are relatively free from distortionary results.
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Moreover, such distortionary effects as being inherent in payroll taxes change can be rectified. For instance, as mentioned just, payroll taxes change affects only those in work, which leaves out for example pensioners. But this defect is easily enough rectified in countries with a state pension structure by temporarily changing the condition pension. Indeed, this type of measure is operative in the U already.K.
Winter gasoline allowance, depending about how cold the wintertime is. A similar point pertains to the SPEED with which fiscal changes can be made. It is properly reasonable to spend weeks if not years debating some fiscal changes before they are implemented. The pressing issues included can be complicated. But that is irrelevant.