. . . President-elect Obama’s candidate for chairman of the Council of Economic Advisers, Christina Romer, herself a Keynesian, has done research that undercuts the Keynesian view of good fiscal policy. Some of this research is in a March 2007 paper, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,” co-authored with her husband, fellow University of California, Berkeley, economist David Romer.
In their article, they find that “tax increases are highly contractionary” and that tax cuts are highly expansionary. Otherwise-careful economists Greg Mankiw of Harvard and Lawrence Lindsey of the American Enterprise Institute have run with this result, as they should, but in doing so they have seriously misstated their findings.
Therefore, it’s worth looking at what the Romers did and didn’t find. Their bottom line is that “exogenous” tax cuts–that is, tax cuts not intended to offset the business cycle–have a large positive effect on gross domestic product. Specifically, a tax cut of 1% of GDP will raise GDP by about 3%.
The Romers’ research actually undercuts the Keynesian approach in a more fundamental way. They find that tax cuts to offset a recession are ineffective, but their reasoning would also apply to government spending increases to offset a recession. In other words, if she believes her own research, Christina Romer should be a strong critic of her new boss’s policies.
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