# How Big Is the Multiplier?

by James Hanley

This guest post is in response to a discussion with Clawback on the multiplier effect of government spending for fiscal stimulus. I argued there was no consensus about whether that multiplier was positive or not, and Clawback argued that there is solid evidence about what the multiplier is, and that the lack of consensus was due only to politics. In starting a response to him based on looking at the literature, I realized it would be too long for a comment, so I have asked Erik to allow me a guest post.

The purpose is not to poke at Clawback, but simply to emphasize the lack of consensus among economists about what multiplier ought to be used as the basis for public policy. The unpleasant fact is that if we are wrong about the multiplier, our policies very likely will be wrong–and that’s true no matter in which direction we are wrong. And if in fact we don’t have any real certainty about what the multiplier is, we can never have certainty about the wisdom of our chosen policies–and that’s true not matter which anti-recessionary economic policy we choose. The purpose here is absolutely not to argue for either a specific multiplier or a specific policy. Also, I apologize up-front if this post is tough slogging. I just don’t know how to translate some of this arcane cant into plain English.

First, a short primer on the multiplier. When you spend a dollar that dollar becomes someone else’s to spend, and when they spend it it becomes someone else’s to spend. How much increased spending this causes is the multiplier. (Mathematically, the formula is Multiplier = 1/Marginal-Propensity-Save, meaning that the more likely people are to save, rather than spend, the smaller the multiplier.) Simply put, a multiplier of 1.0 means that my \$1 in spending has caused total national output to rise by \$1. A multiplier of 1.5 would mean that it caused total national output to rise by \$1.50. And a multiplier of 0.5 would mean that it caused total national output to fall by 50 cents. Obviously, then, we want any fiscal policy–whether spending increases or tax cuts–to have a multiplier of greater than 1.0 or it will actually have a negative effect on the economy. And obviously the higher above 1.0 that it is, the more stimulus effect it will have.

So what is the multiplier for government fiscal policy? Ah, there’s the rub. Our best and brightest aren’t exactly in agreement. Peter Tulip, a senior economics researcher for the Reserve Bank of Australia, says,

Estimation of fiscal multipliers is controversial, and subject to substantial uncertainty.

Why so hard? That mathematical formula looked pretty simple, right? Well, Harold Uhligh says it is simple, but I’m not sure everyone here agrees with his definition of simple.

I contribute to answering that question by calculating fiscal multipliers in a baseline neoclassical growth model with endogenous labor supply and fiscal policy, allowing for government spending transfers, government debt and distortionary taxes on labor and capital income. The policy experiments are conducted holding transfers, consumption taxes and capital income taxes fixed, i.e. changes in taxation require
changes in the distortionary labor tax. The model is simple and fairly standard. [emphasis mine–JH]

So what estimates are there for the multiplier? Let’s start with the Obama administration’s report on the stimulus package, by Romer and Bernstein, which uses a multiplier for government spending of 1.5, which the authors say is the average of the estimated multipliers “from a leading private forecasting firm and the Federal Reserve’s FRB/US model.” Despite using only two numbers for their multipliers (one from from an unnamed source, grrrrr) they say, “The two sets of multipliers are similar and are broadly in line with other estimates.” Of course this is a political document, so there’s some reason for skepticism about how they chose their numbers, but I’m just going to state my discomfort here, and lacking anything resembling actual evidence, not accuse them of cooking the numbers.

But just how reliable is the FRB/US model? FRB researcher Robert Tetlow has analyzed the,

46 vintages of the [FRB/US] model the Federal Reserve Board staff has used to carry out forecasts and policy analysis from 1996 to 2007,

and found that

“model uncertainty is a substantial problem. Changes to the FRB/US model over the period of study were frequent and often important in their implications…the answers to questions a policy maker might ask di¤er depending on the vintage of
the model.”

Granted, Tetlow did not look specifically at the fiscal spending multiplier, but he did look at multipliers for four other variables, and there’s good reason to suspect that his conclusion travels.

Additionally, Romer and Bernstein acknowledge in that paper that

Our estimates of economic relationships and rules of thumb are derived from historical experience and so will not apply exactly
in any given episode.

In short, their multiplier is a guesstimate, folks. An educated and model-based guesstimate by top-notch economists, but yet not a solid reliable fact.

Greg Mankiw, referencing Valerie Ramey suggests a multiplier that’s slightly lower.

The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States’ historical record, Professor Ramey estimates that each dollar of government spending increases the G.D.P. by only 1.4 dollars.”

That’s still positive, but in Mankiw’s words, “not very large.” (Of course Mankiw was/is an economic adviser to Bush/Romney, but before liberals squawk in anger and conservatives squeak in glee, note that Mankiw closes the reprint of this January, 2009 column at his own blog by saying, “given the condition the economy is in right now, I think we ought to be more worried about doing too little than about doing too much.”)

What other estimates are out there? Susan Woodward and Bob Hall suggest that it the multiplier is simply 1.0. At that rate, economic output increases exactly at the rate of government spending, neither boosting the economy nor dragging it down.

Robert Barro is considerably more dismal in his estimate. Focusing on wartime spending because in general “it is not easy to separate movements in government purchases from overall business” he finds the historical evidence–note, not theoretical, but historical–suggests a multiplier of 0.8, a rate that would mean government spending actually harms the economy. There’s room for criticism of Barro’s approach. Yglesias points out that WWII was an anomaly that actually required forced saving–e.g., government forced lack of demand, in contrast to Keynes’ assumption of a consumer-driven fall in demand. He concludes,

The question is whether you got a decent multiplier out of the first 5-10 percent of GDP you spend on stimulus. It shouldn’t surprise us if it turns out that defense spending eventually got somewhat higher than would be economically optimal in the middle of the largest war in history.

Krugman says WWII wass irrelevant because there was full employment. But there are problems with their critique. First, Krugman himself has used WWII as an example of how stimulus works, so as Tyler Cowen notes, “a fundamental decision has to be made on whether to run away from the WWII evidence or not.” Second, Krugman’s “full employment” argument assumes the increased spending of WWII began at a point of full employment, which of course is false–the actual unemployment rate for 1941 was 9.9% (slightly higher than any year in the recent/current crisis). Third, Yglesias and Krugman focus their criticism on WWII–which I think is in itself fair (and I think Krugman’s own use of WWII is wrong as well), but Barro also used WWI, the Korean War, and the Vietnam War in estimating 0.8 (although he gives greater emphasis to WWII), which Yglesias and Krugman ignore.

That doesn’t mean Barro’s right and Yglesias/Krugman are wrong–In fact I share Yglesias’ precise qualms about using WWII–but it does means that Barro’s estimation cannot simply be rejected out of hand.

Let’s return now to Uhlig, who has a fairly nuanced conclusion distinguishing between short-term and long-term multipliers. Analyzing a stimulus plan “similar to the one employed in the American Recovery and Reinvestment Act,” he finds that;

initially, net present value fiscal multipliers for government spending may exceed [1.0] for several years and possibly substantially so. But these fiscal multipliers may be highly misleading, as eventually 5.8 dollars of output are lost for each dollar spent on government stimulus, according to this model.

In other words, the short run multiplier might be pretty darn good, but the end result is a dramatically negative long run multiplier. Uhligh concludes that,

[T]he “price” of the output loss later on may be well worth “suffering” in order to “gain” the initial boost in output. But a discussion of fiscal stimulus without pointing out this price, i.e., the eventual and prolonged growth slowdown in output, appears incomplete.

Exactly. Neither the short run multiplier nor the long run multiplier standing alone provides sufficient guidance for policy. We have to decide whether the short run effects or the long run effects are more important, and reasonable people can disagree.

Further uncertainty about the exact multiplier is introduced in an National Bureau of Economic Research (NBER) working paper by Ilzetski, Mendoza and Végh, who study 44 countries and reach the following conclusions.

(i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rates but is zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are smaller than in closed economies; (iv) fiscal multipliers in high-debt countries are negative.

OK, the U.S. is industrialized, so that’s a plus. We have flexible exchange rates, so that’s a minus. We have an open economy, so that’s a minus. As to high debt, I can’t access the whole paper right now, so I’m not sure how they classify the U.S., and I can see arguments either way on that. Still, that’s not entirely encouraging for the prospects for fiscal stimulus in the U.S.

Further disagreement in the profession about the multiplier is emphasized in a 2009 paper for the IMF, bySilimbergo, Symansky, and Schindler, who write;

The size of the fiscal multiplier is country-, time-, and circumstance-specific. In the March 2009 IMF staff note prepared for the G-20 Ministerial Meeting, a range of multipliers was used.6 The low set of multipliers included 0.3 on revenue, 0.5 on capital spending, and 0.3 on other spending. The high set of multipliers included 0.6 on revenue,1.8 on capital spending, and 1 for other spending…

Answering the question of how multipliers are calculated and whether they are reliable, the authors conclude that;

The profession disagrees on the reliability of the multipliers, partly because of methodological differences, and partly because the range of estimates, even for similar methodologies, is often quite large…

All methodologies have shortcomings and caveats. Any estimate of a multiplier should have in mind the assumptions under which it is valid.

I’ll conclude by returning to Valerie Ramey, who actually says a little bit more beyond her estimate that the multiplier is 1.4. In a paper prepared for a Journal of Economic Literature forum on the multiplier, she concludes;

We now have many more estimates of fiscal multipliers than we did in Fall 2008 and early 2009, when policy-makers were trying to decide whether to use fiscal policy to try to stimulate the economy. Many of the studies are so recent, however, that the profession needs more time to interpret results and to check their robustness before coming to any firm conclusions. At this point, it seems that the bulk of estimates imply that the aggregate multiplier for a temporary rise in government purchases not accompanied by an increase in current distortionary taxes is probably between 0.8 and 1.5.

Let’s parse that out just a bit.

First, “we now have so many more estimates of fiscal multipliers.” Not an estimate, but many different estimates.

Second, “Many…are so recent…that the profession needs more time to interpret the results and check their robustness before coming to any firm conclusions.” This is a 2011 paper, folks, just about a year-and-a-half old; the profession is still interpreting and checking.

Third, “the bulk of the estimates [are] probably between 0.8 and 1.5.” That is, the bulk of the estimates are between a negative effect and a positive effect of government spending. In other words, the bulk of the estimates are that government spending as fiscal policy could boost the economy or could further harm it.

That’s not the worst of it, though. Ramey also pointedly notes that,

most estimates lie in the range of 0.5 to 2 [and] [r]easonable people can argue…that the data do not reject [either] 0.5 or 2.

In other words, a reasonable person could argue that the data are not solid enough to reject the idea that fiscal policy via spending increases could either be much better or much worse than is normally believed.

That’s cold comfort for anyone who’s a policy wonk, for anyone who wants to base their economic policy preferences on data rather than on faith. And that applies both to advocates and critics of stimulus.

## 0 thoughts on “How Big Is the Multiplier?”

1. Patrick Cahalan says:

Doesn’t it suck when the true answer to the question is, “We don’t really know”?

Report

• If you laid all the economists in the world end to end, well, that would be a start.

Report

• James Hanley says:

Just put plenty of enforcer-types between Krugman and Cochrane.

Report

• James Hanley says:

Unfair, Cochrane’s about thirty years younger! And I’ve heard that the freshwater economists are more evil than the saltwater ones, so I’m sure he wouldn’t fight fair.

Report

• Remo says:

Pretty much.

“We have done a lot of calculations and analysis, and our definitive answer to the question is: We have no idea.”

Report

• Only if you are not a scientist – for us, zero is still a statistically valid number.

Report

• BlaiseP says:

If you’re a mere programmer drudge, true and false resolve to how they’re implemented.

#ifndef (TRUE)
#define TRUE (1)
#endif

#ifndef (FALSE)
#define FALSE (0)
#endif

Report

2. Dan Miller says:

How do you square this with other findings suggesting greater consensus that the stimulus lowered unemployment rates relative to where they would be otherwise? The same survey does suggest a bit more uncertainty about whether the long-term benefits outweigh the costs, but a) almost nobody in that cross-ideological panel was willing to say that the costs definitely outweighed the benefits and b) the question of whether to trade short-term benefits for longer-term costs isn’t necessarily an economic question, but one of trading off different values, which economists are no more (or less) qualified to make than anyone else.

Report

• James Hanley says:

I was focusing mostly on the size of the multiplier. Presumably anything above 1.0 would lower unemployment. I think your a) and b) speak for themselves. Lacking clear knowledge about multipliers, it would be very hard to say whether the long-term costs outweigh the short-term benefits or vice-versa. And I agree 100% that the trading off of values is not strictly an economic question. I’m only asking people to be aware that there may actually be such a trade-off, and that the multiplier–whatever it is, but assuming it’s positive–is not necessarily just a straightforward win. (For my part, speaking outside strict economics, I think we’ve been focusing on the short-term for far too long and really need to start thinking about that long term. Reasonable people, as much as I don’t want to admit it, can disagree.)

Report

• Dan Miller says:

Well, OK. But will you concede that there’s a consensus among economists that in the short run, the stimulus lowered unemployment from where it would have been otherwise?

Report

• James Hanley says:

I don’t think I can argue against that. The chart in your link was pretty dispositive, yes? (The comments from the panel are interesting, though.)

But just for funsies I can quote John Cochrane explaining it (or explaining it away, as you might prefer): “I will admit to a bit of disappointment that so many economists revert to archaic Keynesian fallacies when under pressure.”

I’ll admit to having had a sense that a lot of economists backed off their previously held theories when faced with the size of the Great Contraction. Whether that’s out of a pusillanimous failure of nerve or a recognition that this case really is special, who really knows?

Report

• DensityDuck says:

The issue is that while “just let the market sort things out because that will be best in the long term”, that has a whiff of “kill them all, the Lord will know his own” about it. It’s very painful right now to people you know, as opposed to deficit spending (which is painful to people you don’t know at some indiscriminate future point) or raising taxes (which spreads the pain over 350 million people).

Report

• “Well, OK. But will you concede that there’s a consensus among economists that in the short run, the stimulus lowered unemployment from where it would have been otherwise?”

There’s no doubt that government can create full employment if the stimulus is big enough, but that isn’t the point. The point is what kind of damage is done with economic intervention that makes it worse off for workers after an initial drug rush.

Report

3. Uncular 1 says:

But, honestly, all economic policy preferences require faith. I’m sorry, but the social sciences are just not x + y = z type things. All policy wonks make their recommendations with the faith that their view of society is the correct one and that people will act as they predict. Seriously, predicting people’s behavior? That is nothing but blind faith.

Report

• James Hanley says:

Seriously, predicting people’s behavior? That is nothing but blind faith.

I suggest reading up on some behavioral economics. T’ain’t physics, but neither is it religion.

Report

• How do you know that? I could be a figment of your imagination. In fact, we all could. Maybe you are dreaming that there are others.

Report

4. clawback says:

Estimates for the multiplier vary for two main reasons. First, they are affected by the political views of those making the estimates. If there’s any thing one can predict with confidence it’s that the multiplier declines as the estimator moves to the right. Second, and more important, it really shouldn’t be a surprise that the multiplier varies according to the economic conditions present, and so cannot be seen as a single constant. The oft-cited WWII example shows just how silly this can become. Look, there were two entirely distinct economic phases to be considered. Leading into the war we had the most severe depression ever seen; a clear case calling for demand management. And sure enough, as we geared up for war people got jobs and the unemployment rate declined. Up to that point government spending on weapons had a large multiplier because it only put to work resources that were idle. But once all the slack was removed; i.e., when the economy was operating at capacity, no further demand management was possible. If all the factories are busy and the workers are employed, additional government spending, seeking to produce all the tanks, planes, and warships that the economy can produce, can only crowd out other uses for the resources. In that case, then, the multiplier would decline toward, and probably past, one.

This all seems rather obvious to the point of being banal. Cowen’s “AHA! I caught you using WWII to show contradictory things! GOTCHA!” is either in bad faith or just stupid.

Report

• James Hanley says:

Well, I’m particularly sorry that you have chosen to stick to a simplistic it’s-all-political approach. I wrote the post for you, and I wish you could have moved past that position.

Report

• clawback says:

I think if you read my comment carefully you’ll find an actual argument. But suit yourself.

Report

• James Hanley says:

But if you want to insist that the estimates are primarily political, you haven’t really given yourself any ground for defending a particular estimate, except your own political preferences. If you want to stick to “the multiplier declines as the estimator moves to the right,” then you’ve also said “the multiplier increases as the estimator moves to the left,” which gives us just as solid a reason to ignore a Krugman as we have for ignoring a Barro–but we don’t have any economically-based reason for favoring either over the other.

I guess what really bothers me is I studiously avoided making a political argument and relied solely on the writings of professional economists, and you ignored all that to stick to “it’s just political.”

Report

• clawback says:

Well, I’m afraid the observation that multiplier estimates appear to be correlated with one’s political leaning is one I cannot escape whether or not you think that makes me cynical. But that observation does not allow me to throw up my hands and exclaim “Opinions differ! Teach the controversy!” any more than it does when discussing evolution or the Holocaust. It’s entirely possible some economists are attempting real science while others are partisan hacks. But you’re right — none of this tells us which economists are which. So all one can do is examine the respective work and make a judgment. For my money, analyses like those by Krugman, DeLong, and others, that start with “the government’s money is as good as anyone else’s” and go on to explore the nuances of where that money comes from and how it is spent, have far more validity than simple-minded Say’s Law-based proclamations of 100% crowding out by Fama and Cochrane. In my view such proclamations don’t examine all the implications (such as the role of liquidity preference), and they strike me as poorly thought out.

So my grounds for defending a particular estimate of the multiplier is not politics but judgment regarding the quality of the work done.

Report

• Stillwater says:

I don’t exactly know how the argument goes … but I concur! It’s all too easy for theoretical economists to bury their preferences behind a “neutral” presentation of the data. I’ve previously criticized Hayekians for doing exactly that.

Report

• James Hanley says:

Fortunately, only Austrians and right-leaning economists do that, while we can rely on left-leaning economists to be truly scientifically objective.

Report

• Stillwater says:

Ahhh, you missed the point.

Report

• James Hanley says:

Apparently so, and still am. I almost feel like I get it, and then it kind of slips away from me.

But don’t explain, it’s never worth while. And no doubt others will get it just fine. Just call me slow.

Report

• Stillwater says:

Hayekians interpret economic data from an – what should I call it? – an “extra-economic” calculus. So the complain isn’t that everyone with an opinion interprets that data thru a filter. It’s that Austrian’s have multiple filters which economic data has to pass thru before it’s established its bonafides. I’m just not convinced any raw data could ever meet those bonafides. Unfiltered, of course.

Report

• James Hanley says:

clawback,

I’m skeptical that the assumption of equality is really the most defensible assumption. Since different types of spending have different multipliers, it will hold true only if governments spend in pretty much the way private spenders will. If government spends differently, in aggregate, then the multiplier will diverge from private spending, necessarily being either higher or lower. For example, some studies of spending to build public sports stadiums has shown a negative multiplier.

It also assumes zero crowding out. Barro’s beginning assumption of total crowding out does indeed seem to be a bit much, but so does the assumption of zero crowding out.

If your argument is that the assumption of no difference in multiplier between government and private sector is the most parsimonious, I think you’re missing the assumptions built into the assumption.

Report

• clawback says:

But there is no one, literally no one, who thinks the composition of the spending doesn’t matter, nor is there anyone who thinks zero crowding out occurs.

If, to cite a slightly silly hypothetical, a stimulus takes the form of a tax cut targeted to prosperous people near retirement, that stimulus will have little effect because that demographic can be expected to save a large portion of the tax cut. On the other hand, unemployment insurance tends to be very effective stimulus because newly unemployed people will spend all of it, and will spend it on the things they purchased when they were employed.

So stimulus that is spent rather than saved, and is spent on things that had been purchased before the recession began, is likely to be most effective.

And yes, of course crowding out occurs as it did during WWII, and in general it certainly will occur, but the degree of crowding out will be minimal during a period of high unemployment and near zero interest rates.

Now, the effectiveness of one type of spending versus another can legitimately be debated, as can the degree of crowding out under one set of economic circumstances versus another. Sadly, that’s not where the current debate occurs. Instead, we get this:

Every dollar of increased government spending must correspond to one less dollar of private spending.

That’s Cochrane, and it’s pure sloppy hackish bullshit. So sadly no, this is not a high-minded debate among people of good will, but rather a battle between science and hackery.

Report

• James Hanley says:

Every dollar of increased government spending must correspond to one less dollar of private spending.

It seems sloppy because you’re coming from a Keynesian perspective, whereas Cochrane is coming from a new classical perspective. Keynesians think that lack of demand occurs, so that the spending simply isn’t happening, and so government can use that unspent money without crowding any private spending out. If they’re right about the lack of private spending, then that makes sense.

But from the classical and new classical perspective, Keynesians are wrong about the lack of private spending. When an individual doesn’t spend, the money doesn’t go under his/her mattress, but into a bank, where it gets loaned out. If spending and investment do decline, then too much money builds up in banks, and they reduce interest rates to the point where people are willing to borrow–whether to start/expand businesses, buy new homes, fix up old ones, whatever it might be. So if government steps in and takes that money , they are just substituting government spending for private spending that would have happened.

Now it’s fair to disagree with that new classical model. Lots of good economists do. But lots of good economists agree with it, too, so to call it “sloppy hackish bullshit” is not actually a defensible position.

nor is there anyone who thinks zero crowding out occurs.
May I introduce you to Paul Krugman?

Report

• clawback says:

James, did you even read the Krugman piece you linked to? He’s arguing for no crowding out under the very specific condition of the zero lower bound, not generally. Furthermore, he develops the model using strictly new classical assumptions and techniques; which is what he has always done in his academic work, although to lay audiences he tends to use old Keynesian terminology. So I’m afraid this isn’t quite the gotcha you were hoping for.

And no, Cochrane’s statement wasn’t in some similarly nuanced context; it was a blanket assertion of 100% crowding out.

Report

• James Hanley says:

Clawback,

Yes, I did. In fact I’ve read that specific article probably 8 times since it was published. And my point is that some other economists think Krugman is wrong. You’re basing your argument on Krugman saying he is right, but of course no man gets to be the judge of his own cause, nor should any of us accept a person as the judge of his own cause.

Look, agree with Krugman if you want. Just stop blowing smoke up my ass about how he’s the only one being academically objective while all the others are a bunch of politically-driven hacks, and how you have very solid intellectual reasons for favoring Krugman’s view, and your position isn’t based on politics at all.

You’re not actually interested in listening to and thinking about the diverse voices of the professionals. Your choice, but I’m not interested in playing that game.

Report

• clawback says:

Do you have an argument? I don’t find one here.

Report

• Kim says:

” where it gets loaned out. If spending and investment do decline, then too much money builds up in banks, and they reduce interest rates to the point where people are willing to borrow–whether to start/expand businesses, buy new homes, fix up old ones, whatever it might be. So if government steps in and takes that money , they are just substituting government spending for private spending that would have happened.”

I’m pretty sure I can pull some charts from calculated risk showing that the banks have been tightening lending a LOT. Sadly, I can’t get the M3 anymore (at least not from governmental resources).

That is to say: this may very well be a special case, due to the nature of this recession/depression.

It’s also fair to say that America’s recovery is probably also going to be a special case (see our consumers digging themselves out of debt on the backs of Europe).

Report

• BlaiseP says:

You’re conflating many separate problems, James. Private dollars do not always find their way into economically productive venues.

At some point, dollars aren’t spent anymore. They’ve floated to the top, into someone’s pile of investment capital or debt structure. Unless that capital re-enters the spending cycle, it’s frozen. Keynes understood this. He wanted nations to pay for their wars and not put them on the tab. He understood what you clearly are avoiding: money doesn’t always go to banks where it can be loaned out. That’s why the nation once set up a wall between retail and investment banking.

While you ignore the difference, continuing to believe in the zero sum game of private and public dollars, the rest of your argument is moot. Governments can create demand where no other sector can.

Report

• DensityDuck says:

“Governments can create demand where no other sector can.”

Indeed, just look at the smartphone business, which was entirely created by…um…hey, how about those hybrid cars, which demand was completely the result of…well, um…maybe the 787? Nope, still private industry…stem cells?

I guess you could say the government created demand for traumatic brain injury treatments and high-functioning limb replacements. The jury’s still out on whether that’s a demand we wanted to have.

Report

• BlaiseP says:

I don’t guess about what I’m going to say, Duck. When I have something to say, I do. The smartphone business emerged first from military technology. Same with most of the hydrogen powered tech, dumbass, all Space Shuttle / Lawrence Livermore. Boeing began with Navy trained engineers.

But it’s at stem cells where you’re absolutely showing us your flaming baboon’s ass. Human stem cell tech emerged from UW Madison researchers and NIH.

In short, you’re completely wrong. Beyond a certain threshold, government support for large-scale research becomes essential, especially getting these things through to the market. Do us all a favour, eh? Just shut up about what you clearly know nothing about.

Report

• DensityDuck says:

Yes, I’m aware of the origins of microprocessors. That doesn’t mean that the Blackberry was the result of a government contract. Neither was the 787.

I’ve brought up the fact that government (defense, actually) spending into research created technologies that were useful to private concerns. That does not mean that the government “created demand where no other sector could”. I’m pretty sure that the people who put together ARPAnet weren’t thinking about how they were going to destroy the newpaper industry.

Report

• Troublesome Frog says:

It seems sloppy because you’re coming from a Keynesian perspective, whereas Cochrane is coming from a new classical perspective.

Not at all. Based on the models you described above, what’s the difference between these statements?

1) Government can’t grow the economy by borrowing because every dollar borrowed is a dollar a private company can’t borrow, so it nets to zero.
2) Google can’t grow the economy by borrowing because every dollar borrowed is a dollar a different company can’t borrow, so it nets to zero.

You will not find the difference in the model you described above. If Cochrane’s statement (absent the obvious additional assumptions) is true, it proves far too much.

Empirically, what would the crowding out look like? It should take the form of increasing interest rates. By what other mechanism would crowding out occur?

As clawback pointed out, I don’t think you’re reading Krugman very carefully here.

Report

• DBrown says:

This statement:
“1) Government can’t grow the economy by borrowing because every dollar borrowed is a dollar a private company can’t borrow, so it nets to zero.”
is an attempt at a joke? If not your are overlooking the most critical thing any government can do that no other person/company can do – print money.

So, statement 10 is utter BS to support all your points, a joke or ignorance to write home about – I assume a bad joke

Report

• Troublesome Frog says:

DBrown:

A couple things.

1) Calm down. We’re over here and you’re way over there. Read up the thread. This is a thought experiment. We all agree that statement 2 is nonsense, so the question is, how can it be nonsense without statement 1 also being nonsense? The point is that the answer to that question is not in Professor Hanley’s explanation of where savings go. The answer lies in somebody’s backdoor assumptions, not in something special about Cochrane’s beliefs about the disposition of savings.

2) In this model, monetary policy really isn’t part of the question.

Report

• James Hanley says:

DBrown–In this model the assumption is that government isn’t printing money, just borrowing it.

T-Frog–Well, that’s why I’m not really on board with Barro’s hypothetical starting point. Note that I’m not arguing for it–I’m just arguing that there was a simplistic rejection of it. And I’m not sure it really matters in his actual analysis–in the end he doesn’t conclude that there’s a multiplier of 0; he concludes there’s a multiplier of .8.

But another way of looking at your two statements is, “government can’t grow the economy beyond what the private sector can.” That obviously doesn’t bring us back to a multiplier of 0, but it does emphasize that there’s no magic in government spending. All it can do is make up for diminished private spending.

Which brings us back around to the fundamental point of disagreement between Keynesian and Classical models, as I understand it, which is whether Say’s Law ultimately holds or not. And we have Nobel Prize winners telling us it does, and Nobel Prize winners telling us it does not.

So my ultimate point that I’m trying to make is that any non-economist (and perhaps any economist) who claims absolutely certainty on the question is operating on faith, not on a basis of sufficient knowledge.

Report

• Kim says:

James,
What’s Roth’s take on the matter? I suppose econ isn’t like literature, where the latest means “the greatest.”

Report

• Troublesome Frog says:

But another way of looking at your two statements is, “government can’t grow the economy beyond what the private sector can.”

But these are two very different statements, right? One of them is silly and the other is reasonable, even if I’d argue that it’s ultimately incorrect. I’m just intervening here on two issues:

1) The notion that “Every dollar of increased government spending must correspond to one less dollar of private spending,” is not defensible as written. In fact, after the initial blogospheric dust-up over it, I don’t think anybody is still willing to stand behind it.

2) Krugman’s post saying that even the assumption of 100% perfect Ricardian equivalence doesn’t result in crowding out is not Krugman saying that he believes in 0 crowding out. That’s simply an incorrect “gotcha” reading of a perfectly reasonable argument.

Report

5. BlaiseP says:

Different stimuli produce different multipliers. The general rule of thumb is: the deeper into the economy the dollar goes, the higher the multiplier effect will be. In other words, the more times that dollar is spent before it ends up in someone’s long-term investment, the better.

Case in point: the bank bailouts. Had all those dollars entered the market at once, we would have entered into an inflationary cycle. They didn’t, because the banks needed cash on their balance sheets. The banks went back to making money and paid back the government as quickly as they could manage. The government stands to make some money from the bailouts, but nowhere near the multiplier of, say, an infrastructure project.

Report

• If even a reasonable share of those dollars had entered the domestic real economy, the effects might have been more effective than they were. The world has changed dramatically over the last 30 years, and many of those changes have broken the Fed’s primary tool. 30 years ago, commercial banks had to make loans rather than investing in financial instruments; no longer true. 30 years ago, it was hard for US commercial banks to provide capital for investment in foreign countries; no long true. 30 years ago, commercial banks pretty much had to have reasonable standards for mortgages, either residential or commercial; prior to the crisis, that had become generally untrue. 30 years ago, commercial banks who took cheap Fed money had to route it into domestic business loans that drove hiring; today, not nearly so much.

Time for Bernanke to admit to Congress that there’s nothing he can do to drive domestic employment. Actually, he’s come pretty close to that — Congress either isn’t listening or doesn’t care.

Report

• BlaiseP says:

All that is true, Michael. It’s time for Congress to admit to Bernanke they tore up the transmission in the family car.

Report

Good post James!

I read a paper somewhere else a few years ago that also put the WWII multiplier below 1, I can’t remember whose it was but it wasn’t Barro – it was someone more leftish IIRC.

That said, I think Yglesias’ points are quite valid – it seems to me a “multiplier” isn’t any kind of constant in the first place, as much as it’s the result of the interplay of a multitude of other variables – what the spending is buying being maybe the biggest one but even that one not controlling. Good investments obviously would make more sense than paying people to break things.
I remember positing at the time I read the paper that it seemed to me perfectly logical that war spending would appear to have low multiplier effects because a significant amount of the spending is used on taking resources out of the economy and literally destroying them.

Coming up with a number to claim as a multiplier ex ante seems to be assuming so much more knowledge than we’re anywhere near having.

Report

• Kim says:

yeah, I kinda hate the idea of -a- multiplier.
Obviously there’s different ones depending on who’s investing, how it’s being invested, what the competitors are.

“Shovel ready” projects made a HELL of a lot of sense when your “demand destruction” happened in Construction! [again, specific case!]

Report

7. James Hanley says:

Hey, I just noticed Erik spelled my last name wrong. I guess he’s getting even with me for spelling his name with a “c” once.

Report

• Rtod says:

Actually that was my bad. Apologies! Thanks Pat.

Report

• James Hanley says:

What did I ever do to you, Tod? ;)

Thanks, Pat.

Even with that, though, I’m having a better day than Justin Verlander.

Report

8. zic says:

I’m no economist. That said, I think not all \$ and their potential multipliers are created equal. Some are bound to be losers, costing more then the benefits gained from them.

Despite the massive infrastructure problems around the country, there were not enough projects ready to build. This is a political problem, but one of a lack of political will to plan, particularly at the local and state government level. Planning smacks of ‘big government’ yet it’s actually the hallmark of competent government. It costs money. It’s a long drawn out public process, almost always contentious, it’s burdensome to administrators managing city halls and state bureaus already understaffed. Planning irritates the natives.

The difficulty of injecting big-multiplier stimulus into the economy during the recession reveals the lack of planning that goes on, because there was a lack of shovel-ready projects. This resulted in a lot of other spending that simply propped state governments faced with a revenue cliff, without much multiplier effect because there were no new jobs created, no growth created. Much of the tax cuts for middle and upper income families (meaning those who maintained their jobs and were able to keep up with mortgage payments) went into paying down debt and were not circulated back into the economy; remember, it became trendy to not buy stuff.

I’m no economists, but it’s pretty obvious that not every dollar spent by government should be expected to have a positive multiplier. And the dollars that might have a big multiplier are dollars local governments are often reluctant to spend.

Report

• James Hanley says:

there was a lack of shovel-ready projects.

And given the worrying number of failing or ready-to-fail bridges in the U.S., along with failing water and sewer systems, that’s a damn shame.

Report

• Troublesome Frog says:

One thing we seem to do very badly here is keep a lid on the cost of new public construction. I’ve lost the link, but there was an interesting study indicating that we do a much worse job than most of Europe in that area.

Report

• Jesse Ewiak says:

I hate to say it, but I think local/state governments having more power has a lot to do with this. It’s unlikely a construction company is going to have the pull to get a random legislator in a national election to do favors for them when handing out contracts (you need to be a national presence like a defense contractor or major bank to do that :)), but on the other hand, if you’re a state legislator or county council member, a \$5,000 or \$10,000 donation can go a long way to getting that contract for the road building or bridge construction in an area.

Report

• Ideally of course procurement should be entirely isolated from political control. That would be extremely difficult given the nature of the US government though.

Report

• James Hanley says:

Jesse,

I can’t dismiss that out of hand, but take note of zic’s response just below. There’s a tension between your claim that political favors are more likely to lead to costly projects at the local level and his claim that the pressures to keep costs down lead to corner-cutting.

That’s an issue worth exploring, but off the top of my head I’m not sure just how to get real purchase on it.

Report

• Kim says:

\$1000 is about the cost of entry, for a favor from a national politician. [note: favor, steering, doing something that he’ll get patted on the back for. NOT going against constituents interests]

Report

• zic says:

At least for small rural projects, sometimes I think it’s urge to keep cost down that causes (or continues) problems; it feeds the corner-cutting urge. Sometimes, the folk with the right connections, not the right skill set, get the job. As in purchasing a used car, cheaper is not always the best solution.

Report

• Kim says:

not “new construction”. what we worry about is repairing old construction, which is far more expensive.

Report

• Matty says:

have I ever mentioned I hate the phrase shovel-ready, there is a lot of work involved in designing and planning new infrastructure before a single shovel hits the ground. It’s a pedantic point of course because money is being spent at the pre-construction stages as well but if people are expecting projects where the bulldozers are sitting ready to roll as soon as someone offers to pay they are going to be disappointed.

Report

• James Hanley says:

When I first heard the phrase shovel ready I thought we were going to be digging a lot of graves fir the victims of Obama’s death squads.

Report

• Matty says:

Having seen Looper at the weekend I can tell you that Obama’s victims are actually sent back in time using the same time machine with which he faked evidence of his birth in Hawaii. Rumour has it they are buried underneath Mount Rushmore.

Report

• MikeSchilling says:

I thought they’d be hiring squadrons of PR people.

Report

• BlaiseP says:

I don’t mind the phrase “shovel-ready” but I do agree with your points. They aren’t pedantic. I’d like to add a few more.

Any project of this sort is an ongoing proposition. Any large bridge or roadway is under near-constant maintenance. It’s pointless to build such structures without planning and budgeting for upkeep.

This goes to James Hanley’s point about the way we’ve systematically underfunded maintenance, which I would amplify by noting the longer needed maintenance is deferred, the more-costly the necessary repairs become, inevitably leading to some not-shovel-ready project: the replacement of what could have been merely repaired.

Report

• Matty says:

In calling my point pedantic I was thinking that it doesn’t matter for the purpose of getting money out there if it is spent on bricklayers or architects. However thinking a bit more there is a problem with having shovel ready projects there when the stimulus arrives. It implies local governments should have paid for all the stages that come before construction and then left those projects hanging there indefinitely in the hope that the final stage would be funded by someone else.

This would seem to be high risk and take money from other things, like maintenance. Not to mention they couldn’t do the job just once because in a few years things will have changed and the best route for the new road or material for the bridge may be different.

Report

• Kim says:

Why do we build things that will be so costly to maintain?
I’m sorry, but america “makes do” with 1960’s infrastructure.

Report

• James Hanley says:

Why do we build things that will be so costly to maintain?

I believe the physicists call it “entropy.”

Report

• Kim says:

Then, my dearest friend, why is it that our oldest roads cost the least to maintain?
If you’re referring to the entropy of governmental agencies, I must say that you’ve discovered something that our more libertarian minded friends say doesn’t exist.

Report

• DensityDuck says:

“why is it that our oldest roads cost the least to maintain?”

Because nobody drives on them. Which, as a side note, is how they got to be the oldest roads–because, since nobody uses them, they don’t need to be rebuilt as often.

Report

• James Hanley says:

I think we have a winner.

And in my area, the oldest roads tend to be dirt. I’m pretty sure I know why they cost less to maintain.

Report

• Kim says:

Not at all, my dear. those WPA roads last a LONG time, even if people use them regularly. Built better, you see.

Report

• Kim says:

and electrical systems! and our piss-poor high speed internet system (which, I’ll grant, isn’t falling apart, but could really stand some improvement)

Report

• DensityDuck says:

“the dollars that might have a big multiplier are dollars local governments are often reluctant to spend.”

I’m pretty sure that the local government would be happy to go down the street to Bob’s Paving Service, give him a bunch of money, and have him pave the road. He’d probably do a pretty good job, too.

Except, y’know, what if he doesn’t do a good job? Then that money would be wasted! We better get Bob to describe his paving plan so we can review it. Actually, let’s go one better and just tell Bob how to pave the road. And, of course, we’ll have to do a lot of training and certification activities to make sure Bob knows how to pave the road just like we want it.

Although maybe Bob isn’t the cheapest. We wouldn’t want to waste the taxpayers’ money by spending too much of it, right? Better ask for bids from a couple of paving contractors just to make sure.

And we do want to make sure that underprivileged persons get a fair shot, while also making sure that we aren’t giving taxpayer money to illegal aliens. So we’ll have to review the demographics and Social Security records of all of Bob’s (or whoever’s) workforce.

Now suddenly it’s a year later and somehow we’ve spent all the money but haven’t actually given any of it to the people who were supposed to get it. But by God we’re sure we didn’t waste any of it. We’ve got the records to prove that every dollar spent was in the name of avoiding waste. Which is just what the people who elected the people who hired the people who hired the people who hired us(*) said they wanted, right?

(*) the recursion is not an error

Report

9. Damon says:

I thought this was a farily reasonable post. Well, except for the quotes from that tool from Slate….

But something I didn’t see addressed is this: The multiplier: “When you spend a dollar that dollar becomes someone else’s to spend, and when they spend it, it becomes someone else’s to spend. How much increased spending this causes is the multiplier”. So, in terms of fiscal policy, the gov’t obtains money from three sources: taxes, bonds, or printing. Excluding foreign entities in play, all the money, the gov’t has comes from citizens, if it doesn’t come from being printed. So regardless of the equation on the right side, you’re not addressing the left side, i.e. if the gov’t taxes me 100 dollars and then spends it, your calculation of the multiplier lies solely on the impact of gov’t spending the 100 dollars. Since that 100 dollars has been taken from me, where’s that negative? That’s not money I have that I could have spent. I could have saved or spent some or all of that 100 dollars. Sounds to me like the you’re missing that component.

Report

• DensityDuck says:

The assumption is that if the multiplier is 1.0, then it doesn’t matter whether you spend 100 dollars or the government takes 100 dollars and spends it. The economy just sees 100 dollars being spent. You personally might see 100 dollars less of benefit, but someone else will see an extra 100 dollars (or, more likely, 100 people will benefit 1 dollar each.)

Report

• Damon says:

Well, actually, if the gov’t spends it, it spends less than the amount taken in as it has to pay for administrative and other internal costs, so at the margin, the multiplier is negative by some amount.

Report

• Troublesome Frog says:

How does the government spend money on overhead without spending it back into the economy?

I think a lot of this confusion comes from the notion that while private spending always circulates back into the economy, government spending is somehow special.

Report

• Damon says:

My bad. I should have inserted “productive” into the converstion….

Report

• Kim says:

as if we don’t spend 10+% of our health care dollars (before obamacare) on WASTE AND UNNECESSARY ADMIN.

Administration is a drag on any large entity. It is balanced by the economies of scale.

Report

10. Bit remiss in not mentioning the days-ago IMF paper on the European austerity experience and the fiscal multiplier. The paper is here. From page 41:

This box sheds light on these issues using international evidence. The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.

Here’s Yglesias on the report, also making some comments which bear on the military spending examples. Here’s Seeking Alpha, and Eichengreen and O’Rourke on the report.

Here’s Tyler Cowen saying if you remove some data points you get a different result.

Report

• James Hanley says:

Remiss, indeed. I missed that one, and not sure, given how much attention it’s received. I would have thought it would have come to the fore in my searches. Thank you for bringing it in, with links to the attendant commentary on it.

Report

• James Hanley says:

Here is an article from the Financial Times that questions the robustness of the study, but more importantly makes available data for stats savvy folks to do their own checking. Sadly, I’m not one of those folks, but I know we have a few here. I’d love to here from them.