Greconomics

I was thinking about the best ways the government can stimulate the economy and came upon a little puzzle for which I have a grand little insight.

The puzzle appeared as I was looking into the debate between tax cuts and government spending, which really boils down to a debate between tax multipliers and fiscal policy multipliers. "The multipliers measure bang for the buck--the amount of short-run GDP expansion one gets from a dollar of spending hikes or tax cuts.
The idea is for the government to either increase government spending (the government increases its purchases of goods and services) or to decrease taxes (the government gives consumers and firms a tax break in order to induce an increase in their spending on goods and services)." - http://homepage.smc.edu/szekely_claudia/OnlineE2/LecturesF05/lectureFiscalPolicy.htm

Going deeper, the effect of a tax cut boils down to the "marginal propensity to consume" (mpc), or how much of a windfall people will actually spend. For example, if you get an extra $1000, will you spend all $1000 or spend $800 and save $200? If you spend all of the money, then your mpc = 1; if you spend $800, then your mpc = 0.8. So, if the government gives you a tax cut, how much of that extra money are you going to spend (to boost the economy)? According to the logic of those who oppose the tax cut, the fact that the mpc is less than 1 means that a trillion dollar tax cut will generate less than a trillion dollars of economic stimulus.

This is a bit of a puzzle to me because money put into the banks is spent by the banks, is it not? Most of it is, anyway - they are required to keep a certain percentage of their holdings in reserve, but the required reserve ratio in the US is only 10%. So, even if the mpc was 0 (100% of the windfall tax cut was saved), the banks would spend 90% of it, so the real mpc = 0.9. In other words, the minimum mpc is determined by the required reserve ratio. (This is my grand little insight.)

You can read about the rest of the debate in other, better written, blogs and op-ed pieces, if you're interested. I just wanted to get to the required reserve insight.

Two other points, though:
1) If you get a windfall, you are probably more likely to spend it on stupid things, including black-market items like drugs. This might further depress the mpc derived from empirical data.
2) Spending effects lobbyists and special interest groups much more powerfully and directly than general tax cuts. So the political return on investment is much better for spending than for tax-cuts. This moves the debate into the patronage realm – third world (3rd grade) politics. http://en.wikipedia.org/wiki/Patronage