It's pretty weird that we use interest rate hikes to reduce aggregate demand
So then maybe DEFINITELY don't do "inflation relief payments" like some state governments did? Can we all agree those were one of the worst policy ideas ever?
This article misses an important point about why interest rates are used to control inflation rather than taxes. This point is the whole reason why interest rates are used to control inflation in the first place, and the author seems to be unaware of it.
When inflation is expected to be high, *real interest rates are too low*. The real interest rate is equal to the nominal rate minus expected inflation. The reason to raise *nominal* rates is in order to bring real rates back to the correct level. Put differently, inflation results in distorted incentives to consume and invest today relative to tomorrow. That's why intertemporal prices (i.e., interest rates) are used to control inflation.
By contrast, the VAT proposal doesn't directly address intertemporal prices, and it could even have perverse effects. Suppose that people expect inflation this year to be high. Then people anticipate that *next year*, the central bank will raise the VAT. This makes consumption next year more expensive relative to consumption this year, which effectively lowers the real interest rate and boosts demand now.
1st. Hey guys. I will go read now.
1. inflation: they raised the number of points you need to get a free Starbucks drink. Used to be 150, now its 200. Damn it.
2. Taxes of Upper Middle Class. So apparently this is me, though I dont feel like it (mainly because I have so many damn kids)... but what I trip out on is just how much taxes I pay. (40-50K a year). I really don't feel like I get much for my money (yes, this is the Republican in me).
3. So much Yale in this article... I should find out next week if my daughter is getting in (it's a long shot... but not impossible)
4. Inflation Part 2: Brother-in-law just raised all his prices by a dollar at his restaurants in Boise. Very little customer complaints, which means they expected it.
5. VAT: I lived in Europe for 12-years. Sure things were more expensive, but at least I knew what I was going to pay.
Random Thought Not Related: I had two daughters who were considering computer science as a Major... with the layoffs in Tech and now the advent of AI ChatGPT, I am starting to think engineering might be a better bet.
Bonus: I just posted about daughters college acceptance status: See link in my bio or go to here. https://hesterscollide.substack.com/p/audreys-college-acceptance-update?sd=pf
I think the reason why we outsource inflation fighting to the fed is raising taxes is unpopular while the fed raising interest rates is opaque and detached. Biden can pretend he wouldn’t have made the call to not acknowledge it when in reality HE nominated Powell.
"This all seems very unlikely to happen. But as a matter of good public policy, it should."
Dammit. How did you guys get a sneak peak at my tombstone?
What I was told in my Macro 101 class was that interest rate hikes are superior to tax hikes for addressing inflation because of the permanent/temporary distinction. Basically, fiscal policy changes (tax and spend changes) are more likely to have their desired effect if they're perceived as permanent rather than temporary. The problem is that usually inflation is a temporary problem. It's easier for the Fed to raise rates during a period of inflation, then drop them when inflation is over than for congress to do the same with taxes. Of course if congress passes a temporary tax hike, the effect won't be as strong as if it signals that the tax increases are permanent, so it's a catch 22.
BUT, if we had a VAT that could be adjusted at will as is suggested in the article, that might work. IS/LM model simplified = raising interest rates to curb inflation curbs inflation but raises interest rates (duh). Curtailing FISCAL policy by either raising taxes or cutting spending both drives down inflation AND interest rates. So, take your pick.
Delegating tax authority to the Fed would indeed "almost certainly be deemed unconstitutional", as well as antidemocratic, but, if using variable VAT rates is indeed as good an idea for fighting inflation as you say, don't give up that easily. Use your imagination to think outside the stale legal boxes and categories that much of the Democratic legal elite is stuck in, a time warp since the 1930s.
It's not necessary to delegate lawmaking power to the Fed to do this. Congress could pass a law, or ratify a technical regulation written by an agency, prescribing in a lot of detail exactly how the rates should change in response to changes in the inflation rate. Require the Fed, or some other statistics-gathering Federal agencies, to regularly compile and publish inflation rates, as accurately and honestly as possible. And then require the IRS to adjust the CAT rates according to the published inflation rates, in the manner that Congress specified. In simplest form, it could actually be a table, showing that if the inflation rate is X, then the VAT rate is Y.
One unspoken advantage of interest rates as policy is they ripple out automatically - they don't require anyone to do anything specific.
I do software development, and I can tell you that it would take a lot of extra effort to get everyone in compliance with a VAT that can change arbitrarily week-by-week. Obviously this isn't impossibly hard, especially for modern systems. But it would be a nightmare for people with older systems that wouldn't be designed to handle something that complicated.
You'd need to have rules around how rapidly you need to be in compliance with a VAT change. Make that window short, and lots of people will yell that you're being unfair and making unreasonable demands. Make the window long and savvy operators will exploit that to the hilt to minimize their VAT payments.
Rather than increasing taxes, why not decrease spending?
There is a way around the constitutional problems with delegating taxing authority: fixed tax increases combined with counter-cyclical supplements to benefits. First, raise the income tax enough to fund the new spending and possibly reduce the structural deficit a bit. Whether you should hit the top half or top quarter of the income distribution is debatable, though it is clear you have to go deeper than the top one or two percent to stabilize aggregate prices. Second, legislate that enhanced unemployment benefits and stimulus payments are disbursed when unemployment exceeds certain thresholds. There could be small enhancements when it exceeds 4.5%, moderate enhancements when it exceeds 5.5% and big enhancements when it’s over 6.5%. When unemployment is under 4.5%, there would be increased taxes but no enhanced payments, which would combine to curb inflation.
Leaving aside the unreality of this proposal, as our authors readily admit, would we *want* to put management of the business cycles entirely in the hands of technocrats? We've already gone halfway in that direction, with Fed control of interest rates, but would it make sense to give them the other, fiscal, tool to do so as well?
I'm a good government, solid Democrat type of person, and I quail at that prospect. I don't fully trust people who are entirely removed from the political (i.e., democratic) process.
Interest rates have been artificially low for a long time. I'm not THAT old but I can remember when you could routinely get 5% interest from an ordinary savings account.
That the interest rate on savings dropped to essentially zero was the result of so-called "quantitative easing" - printing money to finance chronic budget deficits. You can argue whether spending was too high or taxes too low, but these deficits were, and still are, the root of many economic evils.
It’s amazing how little blame TCJA has gotten for inflation
Taxing the wealth of the wealthy I think would be more just than taxing upper half of labor income though. I think it would also long term shift productive capacity away from mega yachts towards broadly accessible goods.
OK if letting the Fed set VAT rates were possible bumped up and down by a few basis points like interest rates then, yes that could be "best." And EPA should levy pigou taxes on CO2 emissions and other pollutants. FEMA should set the rates on Federal disaster insurance. Etc.
Again, I'll take your position as really an argument for a regime change in which fiscal deficits are much lower and Fed-set interest rates are much lower.
BTW higher interest rates do not necessarily need to stress bank. It they are aware that the can happen, banks can lend with VR instruments. The Treasury could finance small, transitory deficits around zero with ST instruments or VR longer term instruments.
Progressive marginal tax rates: The original means testing for state subsidies and the social safety net!
I'm not sure how politically palatable it would be to increase prices even more by raising consumption taxes when prices are already increasing too fast for people's comfort.
Under this policy, price increases due to inflation will be faster and larger, but presumably stop increasing sooner. Is this what the average person wants? People complaining about the prices of things will be even more impacted by faster and larger price increases.