In support of dynamic scoring

Estimating the impact of tax cuts is a tricky business. You can fairly easily calculate how the revenue from current income and spending will change, but that’s just the beginning. The problem is that people don’t stand still: they change their earning and spending habits in response to your tax changes, which changes the revenues from the taxes. The UK government is pretty good at estimating that but economists have long known that there are a couple more stages before you have a full picture of what’s going on. That’s why HM Treasury has begun to use a dynamic, computable, general-equilibrium (CGE) model to estimate the effect of tax changes.

CGE models bring us closer to reality…

The CGE model accounts for the long-term effect on the economy of changing behaviour. In the case of cuts in the fuel duty it accounts for the growth in production caused by a reduction in transport costs. Increasing production generates more road traffic, which yields more fuel duty revenues and partially offsets the cost of the cut. Using the CGE model to ‘dynamically score’ (as the jargon goes) the cost of the tax cut incorporates effects these effects that are not a part of the traditional approach. Read more

Also, careful justifying inequality

You have seen me say that some inequality is “good”, and you have seen Shamubeel say that inequality is “natural”.  It was with this in mind that Shaz told me to post about this comment from Boris Johnson.

Despite calling for more to be done to help talented people from poor backgrounds to advance — including state-funded places at private schools — Mr Johnson said some people would always find it easier to get ahead than others.

He said: “I don’t believe that economic equality is possible; indeed, some measure of inequality is essential for the spirit of envy and keeping up with the Joneses and so on that it is a valuable spur to economic activity.”

I fear that people think the value judgments espoused by Johnson are similar to the ones economists hold when discussing inequality – this is not the case.

Read more

Does the BoE’s view on uncertainty make sense?

Uncertainty is an unavoidable element of policy decisions. In the words of the great Donald Rumsfeld, we must confront the unknown unknowns. In this appearance the BoE’s chief economist, Spencer Dale, discusses his approach to dealing with uncertainty in the context of forward guidance. Essentially, he says that the Bank doesn’t know how big the output gap is so it has been cautious with forward guidance. He suggests that any other course of action would risk pushing up inflation expectations.

His view is understandable, given the Bank’s inflation target, but it is probably not optimal for the UK. Read more

When forward guidance doesn’t guide

VoxEU have recently launched a book on forward guidance and it has demonstrated wonderfully my ignorance of central banking. I thought that when bankers issued ‘forward guidance’ they were doing it to escape the zero lower bound by promising to keep rates lower for longer than they normally would. Something like this:

Source: VoxEU eBook

Source: VoxEU eBook

The ‘Odyssian’ guidance seeks to lift nominal expectations by promising not to tighten policy in future. For a while, the bank’s policy rate will dip below the level you’d expect if they were never at the ZLB. That is the sort of guidance that the Bank of England has explicitly disavowed. Read more