What happened to the fiscal stimulus multiplier?
Arnold Kling makes an important contribution to the debate about fiscal stimulus and double dip recessions which was also pointed out to me in the comments of my recent double dip post:
Paul Krugman provides an analysis showing arithmetically that the fiscal stimulus will have a declining contribution to GDP growth, even as stimulus spending increases.
What is interesting to me about this analysis is that the concept of a multiplier has completely disappeared. If you believe in a multiplier, then as far as stimulus goes, the sooner the better. The more you spend this quarter, the more people are employed this quarter, the more they spend next quarter, and so on. If you do not believe in a multiplier, then any time you slow the rate of government spending growth you slow the rate of overall GDP growth.
If there is no multiplier, and we follow the Krugman logic, then we have no choice but to keep increasing government spending until…what point? when it is 100 percent of GDP?
On the other hand, if there is no multiplier, then I think we should question the whole concept of stimulus. With no multiplier, its benefits are almost entirely transitory and artificial.
I wouldn’t call the benefits of fiscal stimulus artificial except to the degree it is used to re-create an unsustainable status quo ante as it has been by Team Obama. And the multiplier is there, it just isn’t powerful enough to overcome the extreme levels of malinvestment and over-indebtedness in merely one year. This is not a one-and-you’re-done cycle. We are looking at a decade-long process – longer if we continue to bail out companies that have failed.
Team Obama is taking victory laps right now, but I suspect they will change their tune come mid-2010 – and it will be because of the debt and overcapacity not because fiscal policy multipliers didn’t exist.
About Edward Harrison
- Wither stimulus 1 Dec 2009
- Some tidbits about stimulus, recovery, and the Great Depression 10 Feb 2009
- Japan does not demonstrate the failure of stimulus 3 Nov 2009
- Japan: stimulus without reform leads to a policy cul de sac 2 Nov 2009
- Moving away from stimulus happy talk to focus on malinvestment 21 Dec 2009
Ed,
I totally agree with you that the stimulus will be ineffective compared to the malinvestment in the economy, and it will take a few years to work through this. However, I really don’t believe stimulus spending is useful over the long term. There is no multiplier since the money has to be taken from the private sector eventually from taxes (even if it is initially borrowed). Second, the government does not allocate the capital as well as the private sector due to inefficiencies in government agencies and the favoritism given to the industries with the best lobbying efforts. At best, the government pulls future demand forward, but that guarantees a future swoon.
The only thing that multiplies from fiscal spending is debt.