Monday, January 22, 2007

"Why I can't join Pigou Club"

The No Pigou Club welcomes Russell Roberts! After a podcast interview with Greg Mankiw, Russell concludes that while he likes the theory of Pigou taxes on gasoline, the practice will turn into a political mess. He's on the right track, just not far enough down to realize how off-base the Pigovians are. Greg Mankiw's claim that sometime you have to put up with bad politics to get to good economic policy misses at least part of the main point. If it involves a political move, it likely is bad economic policy.


Anonymous Anonymous said...

Can someone tell me if raising taxes on gasoline can theoretically cause inflation, because of all the shipments and trucks that have to move goods back and forth? Can such a link be studied or would it be hard to predict?

8:17 PM  
Blogger Edward said...

Hi Anon,

Inflation is just a measure of the % change in prices of a certain basket of goods over a period of time (usually measured year on year- e.g. prices May 2008 compared to prices May 2007).

If there is a one off increase in the tax on fuel, then this will cause the cost of goods that rely on the fuel (assuming they are not exempt) to rise. This, as you rightly identify, will particularly hit those goods that require transportation.

If we also assume that this cost rise is translated directly into a price rise (i.e. the consumer bears the burden, ceterus paraibus profit margins aren't eroded), then prices will be higher after the tax than before, so there will be inflation.

However, because the taxes don't increase again in the following period, price rises return to 'normal' and so inflation falls again.

An aside of this, is to mention that a central bank (e.g. the fed) should therefore not try to combat this inflation as they know it will only last one period.
Problems arise, however, if the one period inflation generates 2nd round effects. That is to say, people see the inflation level rise, expect to stay that way and therefore increase their wage demands - generating the same level of inflation next period.
The central bank therefore needs to be able to credibly threaten to raise interest rates in the medium run to combat this, even if they don't in the short run.

I hope that helps!

9:58 AM  

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