Matt Nolan

On the issue of crowding out

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Eugene Fama has written a much maligned post on stimulus packages. As a medium-long term view there is really nothing wrong with it, but the large swath of criticisms that have appeared focus on the fact that the author appears to be implying that there is no short-term stabilisation possible from expansionary fiscal policy – namely, government investment is completely crowded out.

Given that everyone else is talking about it, I thought I would add my relatively inconsequential two cents 😉 . This is from an email I sent along to CPW.

http://gregmankiw.blogspot.com/2009/01/fama-on-fiscal-stimulus.html

I’m really with Greg Mankiw.

I think that the criticism that Brad Delong laid out – that inventory is counted as investment but is over-valued – is really a second order issue. The main issue with this is that the mix of credit rationing and a flight to quality does support the idea that there is not complete crowding out – contrary to what Fama implicitly assumes. This in turn implies that government spending can smooth the economic cycle.

How does this hold with the S=I identity? I would say that:

  • Given the existence of “low risk” government investment this (an increase in government investment) would lead to an increase in savings to match the increase in investment – people are more willing to loan to government than business after all,
  • Given the presumption of unemployed resources (and credit constraints) there is scope for an exogenous positive shock to invest (which government investment is) to lead to an increase in equilibrium savings and investment – given that the use of unemployed resources creates value which could not be picked up by the private sector because of credit constraints/catatonic fear.

Even if I thought that the US was at potential (which I don’t – I just think the output gap could be overestimated) the whole attitude to risk and credit rationing surely implies that complete crowding out does not hold – sure S=I always holds, but not complete crowding out.

I realise I’m not adding anything to the debate. However, this blog is a good place for me to store things the way I see them at a given point in time, and thats just what I’m doing damn it 😀

If anyone thinks I’m talking crack, feel free to tell me in the comments 😉

Note: In case it isn’t clear the first mechanism reduces consumption, so no instantaneous stimulus even in the face of no crowding out! However, it does allow for a “reallocation” from consumption to investment, if the price signal was screwy for some reason this could be optimal.

The second leads to an indeterminate change in consumption (given the first mechanism – the income effect in of itself will increase consumption), but a net stimulus.

These are important factors to note when we ask “is an increase in government investment increasing output” and furthermore “is an increase in GI increasing welfare” – which is the ultimate goal.

Note2:  There is also the case where public investment is more productive than private investment.  I don’t think this case is as unlikely as people say – given that the government may have easier access to some resources than the private sector (and given the possibility of increasing returns to scale, especially in a small place like New Zealand).

Matt Nolan

No money? No problem!

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Or so says a recent spam email:

No Money? No Problem!

You’re entitled to government funding and can claim it here

Government money is readily available for many reasons including:
# Business setup / expansion
# Real estate purchase and renovation
# Rent payment assistance
# Bills
# Education
# Equipment
# And Much Much More!

All you have to do is know where and how to ask!

Get our complimentary information kit here

Now, just before I celebrate my “free money” I find that if I go to the hyperlink I end up with this.  “Sorry, we cannot service your country”.  I guess NZ isn’t as interested in taxing everyone to give me extra buyer power – a pity really 😉

dant03

A justification for taxing congestion: Multiple equilibria with a roading alternative?

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Recent posts below (see “Taxing congestion: how I might justify it“) have sought reasons as to why toll-roads are so often touted as an economically efficient measure. For my part, I am quite sceptical that the are universally efficient, and struggle to find a compelling reason why they are even efficient most of the time. However there are some circumstances where it is quite conceivable that they can be efficient. Where there is a (slower) alternative to the road with a congestion charge, and different drivers place different values on congestion free travel, congestion charges/tolls can lead to an efficient sorting of road users between the (faster) toll road and the (slower) free road, resulting in socially optimal outcomes.

The intuition goes something like this:

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Matt Nolan

Taxing congestion: How I might justify it

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I have not yet been convinced that congestion charging, as a general concept, makes sense (especially given the lack of any comments on the post 😉 ).  However, this does not mean that there won’t be a general set of circumstances where this type of toll charge does make sense.

One situation I can think of is as follows.  Suppose you have a long piece of road, and along the way vehicles join that road.  Now, the vehicles that are joining the stream of traffic create an externality for all the vehicles that are downstream of them – but they do not have to face the cost of this at any point.  As a result, they are not facing the full social cost of their actions.

If we look at the vehicles joining the traffic stream at this point as the “marginal” vehicles then we can see that, even though on average the cost externality falls on those that perpetuate it, at the margin an additional vehicle faces a lower cost for congestion than the congestion they create!  Since people make decisions at the margin we will have “too many” vehicles entering from side streets, and “too much” congestion.

In this case, we should toll the side roads coming onto the motorway.  Furthermore, the closer these roads are to the city (which is the likely destination of most of the vehicles) the greater the charge should be.

This is my attempt to justify a toll based on congestion.  Notice, in this case a blanket toll, or a toll based on the quantity of congestion isn’t the right toll – the suboptimal solution occurs because vehicles entering the motorway close to the city don’t have to face the congestion, and so do not internalise it.  As a result, this gives us a clearer idea about what actually drives the suboptimal outcome, and how we can solve it.

Feel free to tell me how and why I’ve missed the point 🙂

Matt Nolan

Taxing congestion: Is it helpful?

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A number of fine authors have come in behind taxing congestion today – namely Greg Mankiw and Stephen Dubner.

The justification for “taxing congestion” appears to be Pigovian – someone clogging up the road has a negative externality on everyone else, and so we should tax that externality. However, I feel that this is just half the story.

In the case of congestion, everyone else on the road is also holding up that one person. In fact, on average, one person on the road is suffering the same negative externality as they are providing. As a result, doesn’t the existence of congestion effectively cancel itself out? Sure putting a toll on will reduce congestion – but if we already have the optimal solution why would we want to introduce a tax on top of it. Note: It may be efficient to actually have some congestion, as the goal of policy is to maximise welfare – not minimise congestion.

Now I have made the argument for an externality in the past (here and here) – my thinking was that the externality fell outside of the drivers and on other areas with which driving was a means to (eg work). Of course, I can’t think of a single situation where there isn’t a “price” mechanism to sort this out (eg with work people wages will adjust to sort out the optimal labour market solution in the case of the “externality”).

I would like to hear if anyone has an externality justification for toll roads – bonus points for using the term “non-linearity”.

dant03

The proper way to levy taxation

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The full set of briefings to incoming ministers (BIMs) following the recent election are now helpfully available on a single page, and between them cover a host of quite interesting, practical, and in some cases timely economic questions. One quite meaty suggestion that I noticed in Treasury’s BIM related to taxation, but it was given very little space (perhaps they knew that it would be ignored?).

The full passage is quoted below, but the bit of interest is in the final bullet:

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