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February 6, 2009

An Economist's Advice to President Obama

By Earl A. Thompson

Recessions are ideally prevented by countercyclical variations in the relevant money supply.  As economies falter and the demand for labor wall, monetary authorities should automatically expand the money supply so as to restore the original wage level. 

However, actual monetary authorities apparently lack the willingness and ability to so offset recessionary shocks.  In view of this problem, anti-recessionary cuts in our Federal Income Tax rates have been an exceptionally effective way to prevent extended recessions in the U.S.  Such anti-recessionary tax-cuts have thus been a regular feature of our economy since 1975, immediately after international oil prices began their irregular, recession-inducing, jumps after we lost our energy independence.


The sporadic tax-cuts we have seen since that time have been have been wisely timed by our legislatures to coincide with recessionary pressures and thereby keep our economy reasonably healthy despite its recalcitrant Federal Reserve Bank.


Most recently, Bush's  '07 tax rebates were highly instrumental in preventing a recession in '07, which would have been quite substantial because the '07 jump in international oil prices was accompanied by the spreading burst in our real estate bubble.   However, with a further jump in oil prices and further decline in real-estate prices in '08 calling for additional macroeconomic stimulation but the Iraq war straining our '08 budget, no '08 tax cut emerged to counter the steadily worsening '08 recession.  So we now are in an increasingly serious recession accompanied by an unusually dire bankruptcy and foreclosure wave, a steep recession very similar to the first year of the Great Depression of the 1930's.


So our current recession has grown to where it is an extremely serious threat to the health of our economy for years to come, President Obama and Congress should accede to the demands of at least a few Republican Senators to get the latest Stimulus Bill passed. Informed economic theory, supported by a series of econometric studies, tell us that greater government expenditures matter very little while tax-cuts matter a lot in helping a recessionary economy recover.  This is because greater government expenditures to some extent "crowd out" private expenditures while tax-cuts not only generally improve production incentives but also raise expected inflation rates because people will be more liquid in the future as they will not have to turn over as much currency to the government at future peak-tax-dates.  


So, to the extent that the Republicans are demanding smaller expenditure increases and more extensive tax cuts, these demands should be met rather than risking the health of our severely ailing economy. 

Earl Thompson is professor of economics at UCLA.
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