Wednesday, December 8, 2010
Welcome to the Antipodes
There is an argument that follows from the standard New Keynesian monetary model in cutting the payroll tax one should favor the employer over the employee. The reason being that current real wages are too high, so by lowering them to the employer, the employer will be encouraged to expand hiring, while increasing real after tax incomes of employees will just make them more high. Normally this would be correct, but not during a depression. The key element of a depression is the demand for money and its preference to the demand for goods. Cutting employer costs will increase their profits but their demand for money will override their demand for goods, investment or otherwise. They will not invest it unless they see demand increase which this won't do. Cutting employee costs will increase their take home cash and their demand for money would override their demand for goods, but they are frequently credit constrained. As they are more likely to be credit constrained, increasing their cash flow will lead to more demand for goods to which employers will respond. This is a demand, not supply problem, the demand for money. Giving money to those that need it most is most stimulative of demand. Given the regressiveness of the payroll tax, and the greater credit constraints of the employees, giving money to the employees is most effective. This would not be the case if demand were growing sufficiently, but will be until the demand for money is satisfied.