Paper by Alesina and Ardagna

In a September 15, 2010 Wall Street Journal editorial, Alberto Alesina reports on a paper by himself and Silvia Ardagna. The editorial, entitled “Tax Cuts vs. ‘Stimulus’: The Evidence Is In,” indicates that a key Keynesian notion is wrong.  This is the notion that tax cuts and increases in government expenditures are roughly equivalent in their effects on changing the level of economic activity. It appears that even the direction of the effects may be opposite.

Why is this important?

It is important because of the technology that was used to come to this conclusion. Most of what we know about finance comes to us from event studies in which the researcher looks at a great many events and compares them all in event time: the time leading up to the event, the moment of the event, and the time after the event. What Alesina and Ardagna appear to have done is to do an event study for big macroeconomic policy events. These are events in many countries. Obviously, there are other things going on in these countries that influence the level of economic activity. However, these other explanations should wash out in an event study. This is a very robust approach.

What did they find?

“. . . expansionary adjustments were based mostly on spending cuts while recessionary adjustments were based mostly on tax increases.” (emphasis added)

Who should care?

Well, Keynesians should start to rethink their entire apparatus. On the other hand, supply-siders should be heartened . . . so much so that they should start to put together an apparatus that could explain these results.