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Pocket money won't stimulate economy

By Tony Makin - posted Monday, 30 March 2009


These higher taxes in the future would reduce the amount of disposable income available for future consumption, so that any stimulus the tuckshop bonus provided to total consumption now would lead to a subtraction later on.

This principle applies more widely. That is, any fiscal stimulus that actually works now must be matched by an opposite withdrawal in the future to reduce the budget deficit.

Smart, forward-looking kids could choose another option. They would realise that the tuckshop bonus meant higher future taxes after they left school, so they would save the bonus money for that purpose rather than spend it. Then they would be able to consume more in the future, unlike those who did not save their bonus money. If all school students (rationally) thought about the future consequences of the bonus, it would have no net impact on present consumption.

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The classical British economist David Ricardo suggested this latter effect nearly two centuries ago in the context of debate about how Britain was to pay for its involvement in the Napoleonic wars. Revived more recently by Harvard economist Robert Barro, a strong fiscal stimulus sceptic, in one of the most cited papers in economics, it has become known as the Ricardian equivalence proposition.

In essence, it implies that household saving will rise following a fiscal stimulus, as of course it has. Everyone trained in macroeconomics learns about this proposition. Why federal policymakers have apparently ignored it remains a mystery.

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First published in The Australian on March 25, 2009.



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About the Author

Tony Makin is professor of economics at the Gold Coast campus of Griffith University and author of Global Imbalances, Exchange Rates and Stabilization Policy recently published by Palgrave Macmillan. He is also an the academic advisory board of the Australian Institute for Progress.

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