Interesting, but I still think that having the Fed change interest rates based on current information would be better than this arbitrary rule which has a three-month delay and does not take account of the wider economic situation. Secondly he does not suggest a targeted tax cut, he suggests “a uniform tax rebate per taxpayer or a percentage reduction in each taxpayer’s liability”. A targeted tax cut would only provide less inflationary pressure if the savings rate of the group it went to was higher, of course it would also provide less of a fiscal stimulus.

Towards the end he suggests that if they used fiscal and monetary policy nominal interest rates would not need to fall as far. I can buy that line, however as the additional government spending will be inflationary surely the real interest rate would be the same in each case (although this depends on how ‘sticky’ prices are). I actually think there is a possibility for this type of dual mechanism, which could be sorta cool.

However, in the quote I’m talking about he said that if the Fed did not want to cut rates anymore, they would not lift rates in the face of a large fiscal stimulus as it would not be inflationary. This is nonsense, it would be inflationary, and if the Fed was previously in neutral mode, it would turn hawkish, in order to prevent the quantity of money growing too quickly.

However, I just don’t think that saying “the tax cuts can provide a desirable short-run stimulus without the inflationary impact that would result from a lower interest rate and an increase in the stock of money” is appropriate, ever. A lower interest rate will give the same stimulus as a cut in taxes to the point where the quantity of money is at the same point, the only difference is in the distribution.

Furthermore, tax cuts aren’t usually used as a stabilising instrument (unlike interest rates) because of Ricardian equivalence and the fact that it is more difficult in administrative terms to introduce and remove tax cuts (as well as the fact that governments aren’t the best at handling economic stabilisation). With credit tight, I don’t think Ricardian equivalence will hold, but that does not stop a tax cut being administratively more difficult than a change in interest rates.

He is essentially saying that being so close to a recession, and hence very low/no inflation, a tax cut is preferable to lower interest rates to help the economy recover, and because of the current climate, there is no need to offset the fiscal stimulus with higher interest rates.

Remember one way of viewing inflation is by the rate of growth in the money supply (taking into account increases in output of course). Saying that more money being printed is inflationary is a tautology, we are interested in looking at the factors that lead to a higher quantity of nominal money being required in equilibrium. In this sense, tax cuts are inflationary, as they are the mechanism that leads to an increase in demand for money, which in turn leads to a higher quantity of nominal money in equilibrium (unless money supply is fixed, in which case the nominal interest rate MUST rise).

The point is that Martin said we could have expansionary fiscal policy without changing the nominal interest rate or the quantity of money. This is not possible, as the Fed has to choose a point that is on the money demand curve.

The cut in taxes then increases the claim on money that households have. As a result either the price of money must rise or the quantity of nominal money must increase or a bit of both.

If the government cut spending by the same amount as the tax cut, then we would have no inflationary pressure, however this would not be a fiscal injection as the injection into the economy is meet by an equal withdrawal.

Higher disposable income increases demand for goods, which in turn increases demand for nominal money. Either the price of money can rise (the nominal interest rate), the quantity of money can rise, or a bit of both. What happens is up to the Federal Reserve.