Confidence

Mainly for economists

Francesco Saraceno reminds us nigh the days inward which real of import people believed inward the confidence fairy (aka expansionary financial austerity), which are non thence real far away. He besides points to roughly recent ECB research which shows that confidence - equally measured yesteryear surveys - clearly falls next financial austerity. The confidence fairy, rather than waving her wand to brand everything alright again, may endure making austerity worse. 

However, looking at the inquiry inward special revealed roughly results I constitute at get-go surprising. In particular, revenue cuts accept a bigger number on consumer confidence than spending cuts. In price of gross domestic product impacts, theory - together with most but non all empirical prove - suggests that temporary spending cuts volition accept a larger send on on overall activity than temporary taxation increases, if in that place is no monetary offset together with incentive effects are non real large. Do these empirical results contradiction this?

To respond that you lot involve to enquire 2 farther questions. First, what does consumer confidence genuinely measure? Second, together with possibly to a greater extent than interesting, what data create financial announcements genuinely reveal.

The respond to the get-go enquiry seems to endure a mixture of things, roughly of which relate to the private household’s income, together with roughly related to the full general economical situation. To the extent that the consumer is thinking nigh the former, together with thence it would brand feel that a taxation increment powerfulness accept a larger send on on confidence than a spending cut. This would nation you lot real niggling nigh the economical send on of the 2 types of measure.

The obvious respond to the minute enquiry is that the data conveyed yesteryear an annunciation of a spending cutting or taxation increment is simply itself. If nosotros stick to taxes, together with thence if the annunciation had non been made, the consumer would accept simply assumed lower taxes (for a time, or forever?). But this is naive from an intertemporal perspective, together with clearly non-Ricardian. In the logic of Ricardian Equivalence, a taxation increment today must imply cuts inward taxes tomorrow for a given path of spending.

There are iii alternative, to a greater extent than ‘rational’, ways of thinking nigh the annunciation of a taxation increase. Suppose the electrical flow authorities budget deficit is non sustainable. Taxes either involve to ascension today, or tomorrow afterward to a greater extent than borrowing. The annunciation together with thence tells us nigh the timing of the taxation increase. If Ricardian Equivalence held it would accept no send on on lifetime discounted income, but if for many possible reasons it did non hold, together with thence a taxation increment today could depress consumer confidence. However, to the extent that confidence depended on the full general economical situation, you lot would await ‘bringing forward’ expenditure cuts to accept a much greater send on than bringing frontwards taxation increases (with the caveats noted above), because of consumption smoothing. In that illustration spending cuts should cut down confidence to a greater extent than than taxation increases.

A minute possibility is that a taxation increment could signal something nigh the hereafter economical situation. Perhaps the consumer had idea the deficit was sustainable because they were optimistic nigh hereafter growth, but the taxation increment told them to endure less optimistic. Reduced optimism could atomic number 82 to reduced confidence. To the extent that the financial activity conveys data nigh hereafter pre-tax incomes, the taxation increment conveys the same data equally a spending cut.

A terminal possibility, which is mostly ignored when discussing the plausibility of Ricardian Equivalence, is that the annunciation of a taxation increment tells consumers nigh the composition of whatever consolidation. Suppose over again that the deficit is unsustainable. Either taxes accept to ascension or spending fall, but the consumer does non know which of these volition happen. If spending is together with thence cut, this tells the consumer that taxes volition non rise, which inward price of the consumer’s ain income would stand upwardly for a plus. So inward that illustration a spending cutting could increment consumer confidence.

Trying to evaluate the send on of yesteryear financial actions is complicated, inward large piece of job because it is hard to know what the counterfactual was, or what people idea the counterfactual was. Were changes idea to temporary or permanent? (Governments hardly e'er say, together with fifty-fifty if they did would they endure trusted?) To what extent create people internalise the government’s budget constraint? If they do, are financial changes telling us nigh the timing of taxes or spending, or their mix, or something else? It seems to me that these difficulties arise whether nosotros are trying to assess the send on of financial changes on confidence, or on activity itself.