In response to Tim’s very interesting idea that we could break out of a deflation-depression scenario by promising inflation through the VAT hike route. I find this hard to accept, and possibly too good to be true: because if a VAT rise now or in the future could boost multiperiod demand, the government could fix the economy and its fiscal woes in one leap.
Raising VAT surely hurts aggregate supply. A producer, for any given price, is able or willing to supply less quantity of product. So the AS curve goes up – for any Q, P is higher.
The problem as I see it is that we are in a situation like below. I see the VAT rise promising to push AS1 to AS2. Yes, you might get some consumption brought forward, but to the commercial sector, the mark-ups are like a supply shock: like being told that oil or electricity will double in price. Not “let’s expand” territory.
The sloped lines are short run. The vertical line is long term aggregate supply: what this economy can produce.
What do I think we need? Well, this obviously: a boost to demand. This has been, largely, a demand-shock depression, as the falling price level attested to. People suddenly saved. So we need higher demand. The government can achieve this by using new money to buy things, broadly speaking. It is not something I as a liberal like the idea of, and if the government can persuade other people to buy things by credibly promising to lift NGDP in the future, then that is better. But if they won’t believe the govt, the government doing the buying is a better option.
Finally, if I’m so relaxed about prices rising from AD going up, why aren’t the Right over at Coffee House or Guido or other places? Well, it is because their model of a recession tends to be more like this:
So, whenever some person (normally Conservative) explains that the problem is that we’ve lost the habit of thrift, we all spent too much, we are owed a thorough punishment for this, they are imagining we are in Iceland’s position, or that of Britain in 1980. We need lower demand, they say. Let prices rise to choke it off (though don’t accommodate 2nd round effects). Then the VAT rise suggestion of Tim’s makes very good sense. And that is why Maggie did it – in favour of lower taxes on companies to boost supply. Look at the graph above, it makes perfect sense.
PS. Money Growth figures look disappointing. Note to Spectator readers: this still isn’t Weimar Germany!
PPS. Apologies for the ugly graphs. Microsoft Paint! I have a real job to get on with . . .