A Chequer-Board of Nights and Days

We have been hearing from several quarters the argument that tax cuts boost aggregate demand less than does government spending.  This is worth thinking over a little. I presume the mechanism responsible for this difference is that the tax cuts will not all be spent immediately.

The recipient of a tax cut holds a real option -- he can either spend the money now, or save it for some opportunity that might arise in the future. It may be that, in today's environment of fear, individuals are overvaluing this real option; if true, this would suppress spending and dampen the effect of increased personal wealth (like that from a tax cut) on aggregate demand.

However, it is certainly the case that government spending, by its very nature, assigns the real option no value whatsoever. To favor government spending based on the higher multiplier is to endorse this reasoning.

The real option is known to have some value.  By distributing money to individuals, we are computing that value based on the aggregate of revealed preferences.  By forcing the money to be spent without further consideration, we are refusing to compute that value, and using 0.0 in its place.  

Remember, this is the argument for more government spending.