Do Temporary Measures Lead to Greater Uncertainty?

Uncertainty remains one of the chief causes of the current economic turmoil in the U.S. Americans just don't feel like they know what the world will look like six months or one year from now. As a result, consumers and business remain cautious, so the recovery can't seem to take flight. Some temporary measures have been suggested to stimulate the economy, either by the federal government or the Federal Reserve. Yet, critics worry that temporary changes will just increase uncertainty further. This isn't really true.

Let's take the Bush tax cut extension, for example. Right now, there's tremendous uncertainty around whether or not they'll be extended, and if so, for whom. One proposal out there is to extend all of the cuts temporarily, for a year or two, until a more stable economic recovery has taken hold. Critics say a temporary extension is almost as useless as allowing it to lapse: Americans will just know that it's temporary, continue to restrain their spending, and remain unsure what their future tax obligation will be.

This could be true, but it also could be false. It's possible that some people might save more money if there's a known end to their lower tax rate. But it's also possible that they'll spend more. After all, they would be better off spending more now and saving more later. When taxes are higher they can contribute more to a 401k and other forms of savings that allow pre-tax contributions. So logically, spending could also increase even more than savings.

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But is uncertainty really as great? To be sure, people would know precisely what their tax obligations would be for the next year or two, for however long the cuts were extended. Then, towards the end of time period, uncertainty would return. But assuming that the economy has improved by then, they could be fairly certain that there would not be another extension -- particularly not for wealthier Americans. If there's a major political shift in Washington, however, then that could obviously change. But you can never eliminate politically driven uncertainty in a democracy.

So uncertainty can be limited if you people understand how the world will look once a temporary policy's time is up. Again, turning to a temporary tax cut extension, imagine if it is left in place for two years. During that time, Washington would be prudent to engage in broad, aggressive tax reform, which would take effect when the extension expires. If this were done in the allotted time, then Americans would have relatively strong certainty of what tax policy will dictate in the near- to medium-term. It isn't the temporary measure that creates uncertainty; it's the general discontent with the current tax code, which always seems ripe for changes.

In general, a temporary policy should still affect consumer psychology. Such a measure might not last forever, but it will influence how people make decisions while it's in place. And by dictating a clear direction for broader policy once it expires, lawmakers can avoid allowing uncertainty to mount as its expiration nears.