A Fiscal Fallacy?

Greg Hannsgen | June 17, 2013

We have been advocates of the theory that fiscal tightening is threatening economic recovery (last week, for example).

John Taylor objects to the view that fiscal tightness has been the key to the slowness of growth in the recovery.

In his blog, he states, “As a matter of national income and product accounting, it is true that cuts in state and local government purchases subtract from GDP, but these cuts are mainly an endogenous consequence not an exogenous cause of the weak recovery.

Taylor’s reasoning is that state and local government spending has been constrained by weak tax revenues. This is certainly true.

However, Taylor’s argument seems to imply and rely upon another false dichotomy—variables are either exogenous causes or endogenous outcomes. Is it not more reasonable to say that these reductions in spending at the state and local level are “mainly an endogenous consequence and endogenous cause of the weak recovery”?

(Note for further reading: This scheme of cumulative causation or positive feedback is part of the fiscal trap thesis advanced in a brief I wrote with Dimitri Papadimitriou last summer and fall: especially in a non-sovereign-currency system, spending cuts and slow growth can be part of a vicious cycle or downward spiral. This 2010 Levy Institute brief, among other publications, assessed the extent to which fiscal stimulus of various types can help to break the cycle.)

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