Another possibility is the Fed doesn’t want to cut rates due to inflation risks, and might see a tax cut as sufficient potential
support for demand to allow them to not cut rates and instead address the inflation issue.
This would be based on the mainstream notion (not mine) that monetary policy is for inflation, while fiscal may function to shift demand from one period to another, depending on the degree of ‘Ricardian Equivalence.’ (The mainstream presumption that agents won’t spend extra income from a tax cut as they ‘know’ there will need to be a tax hike later to keep the budget balanced.) The mainstream (again, not me) would also be concerned that the higher govt. deficit would somehow ‘crowd out’ private borrowing. Nonetheless, the Fed does have reasonably strong empirical evidence for them to believe tax cuts do support demand in the short run.
The Upcoming Fiscal Policy Changes
(Forex Factory) There’s a growing consensus among economists that changes in Monetary policy from the Fed will not be able to do enough by themselves to prevent the economy from going into a serious downturn and that a stimulus from a change in Fiscal policy will be required. The fiscal stimulus in this case will probably take the form of a temporary tax cut.
It’s very likely that the current meetings of the Presidents Working Group on Financial markets (a.k.a. the Plunge Protection Team) have been at least in part for the purpose of discussing the ways and means of how they will work and that the actual cuts themselves will be announced during the State of the Union address. It’s also very likely that momentum for this is going to be building in market participants and that just as with a change in monetary policy, the markets themselves will trade according to the ultimate outcome of whatever happens from a fiscal perspective.
Former Clinton Treasury Secretary Lawrence Summers has been talking about this since November. In his opinion, the economy requires between 50 and 75 $Billion in temporary tax cuts. Martin Feldstein of the NBER is also suggesting that due to entrenched problems in the consumer and banking sectors, monetary policy changes will not have the same “traction” and that “some kind of fiscal stimulus” is now required. There’s a precedent here as well: Bush made a temporary tax cut during the 2001 recession so it seems fairly certain he will want to use the same tactic again. However, the implementation of a fiscal policy change will likely be more difficult from a political perspective because things are very different this time around. Back in 2001, Congress was under Republican control so passing the tax cut was relatively easy. Now that the Democrats have control of the Hill, the actual passage could be far more difficult.