## Friday, December 4, 2009

### A New Institutional Macroeconomics?

We had Keynsianism which was based on fiscal policy.  We have Monetarism which was based on monetary policy.  Will we have a new macro paradigm which is based on legal and institutional policy?

I was inspired by Scott Sumner's response to a comment about Japan's massive underground cash economy that I made on his blog.

Doc Merlin, I did my dissertation on currency hoarding and the underground economy.  The ratio of the tax rate to the interest rate is the number of years you can hoard income in cash before you would have been better off paying taxes. In the US that ratio correlates with the cash/GDP ratio over time. That ratio is high in Japan for two reasons; high taxes and low interest. So hoarding cash to evade taxes is profitable. Ironically, the liquidity trap may make their underground economy bigger.

... and also from De Soto's work.
If interest rates are low and taxes are high and if regulation is too onerous people on the whole will avoid the open economy and hide their activities. This will cause GDP will shrink. Transactions rates will slow in the formal economy, and go into the less efficient informal economy.  Formalness is not binary; it is a continuum.  For example if a company would like to go public to gain access to capital, but can't because of the expense of SarOx, it is being less efficient than it could be.  If chooses to avoid going public because the cost of complying with regulation is more than not complying, the entire future economy fails to realize the gains it would have had.

Also, now we have a good way out of a liquidity trap: tax cuts and economic deregulation.  (If the multiplier of fiscal stimulus is less than one as some studies are saying, its also a good idea to cut spending along with the taxes.)

Anything this gives me some examples of things that would help the US get out of a liquidity trap if we were to find ourselves in one:

• Lowering minimum wage

• Removing regressive taxes (Social security tax and medicare in the US, for example.)

• Suspending Sarbane-Oxley

I wonder when this new macro will come about and what it will look like.

For math: Type your TeX math expression, in ....
For example \sqrt{a^2+b^2}
Looks like $$\sqrt{a^2+b^2}$$