Begrudgingly, the disciples of Adam Smith generally agree that without the $787 billion stimulus package that was implemented a little over a year ago, the economy would be in worse shape today than it is, but o’boy (or girl), are we going to pay for it later. While followers of John Maynard Keynes have various gripes – for instance, it wasn’t big enough and/or it was too “back-loaded” – but nevertheless, we’d surely be worse off without it.
But note a key word used above – generally, not universally. And for those holding out, an often used weapon to shoot down any supposed benefits for fiscal policy is something called the “multiplier-effect.” Fiscal multipliers come in two basic forms, spending multipliers and tax multipliers. Such multipliers are the centerpiece of what might be referred to as the crude or vulgar Keynesian model of the macroeconomy. Proponents of government spending as a way out of recession primarily rely on spending multipliers to support their case. It goes something like this: assuming a government expenditures multiplier greater than one of say, two, would mean that for every $1 spent by the government, the result would be a $2 increase in real GDP.
The problem is, according to Harvard – some consider Nobel worthy (not me) – Economist Robert Barro, such multipliers are not greater than one, and according to his estimates, during peacetime are not significantly different than zero. Periodically, Professor Barro dusts off his famous oft-repeated, apples and oranges, study of multipliers to argue against fiscal expansion in op-ed pieces for conservative publications like The Wall Street Journal, which show that wartime multipliers are between zero and one, which implies that a $1 increase in government spending increases real GDP by less than $1. Hence, he points to World War II as a prima facie case against the use of fiscal stimulus because, heck, with massive spending by the government to fight a world war and unemployment below 3 percent and a multiplier-effect of under one, when would it ever be greater than one?!
But there is at least one problem with Dr. Barro’s study and that is, the multiplier effect of government spending depends upon how much is purchased with the government spending generated income – as someone’s spending becomes someone else’s income – and, well, with wartime rationing and the government gobbling up most everything in sight due to the war effort, there wasn’t much to buy. Most studies actually find spending multipliers to be around 1.5, but will obviously differ depending on the condition of the economy and time horizon used.
Ironically, Barro in his early years in academia was a “Keynesian-type” Economist, but would later defect to the Rational Expectationist Camp, which reminds me of the one about the Econ. Professor who, when accused of the fact that over the years she has never changed the questions on her exams, defends her practice by claiming, “Why bother, I just change the answers.” ? ?
