Monday, January 26, 2009

The Stimulus Hoax

I have written before in this space that government stimulus packages have failed to work in the past. The reaction of consumers has been to reduce debt rather than to engage in new spending. But no matter. As politicians are wont to do, their reaction is that what is needed is simply to have an ever bigger spending package - hence Obama's trillion dollar government stimulus. I haven't seen the details but I would wager that most of the package is for growing government rather than increasing consumer spending. However, that aside, the effectiveness of government spending depends on the so-called multiplier. That is what is the impact that increased government spending will have on the economy? Much of my academic career I have assumed that the government multiplier is less than one and probably negative. That is, if the government spends a dollar, it increases GDP by less than a dollar and may even reduce it. Why is this possible? Its because the government has to get the money from somewhere. If it borrows the money, it drives up interest rates and down private investment expenditures as it makes borrowing more expensive for businesses and households. So why isn't this a mere substitute - which would be a multiplier of one? Its because the longer term effects of reducing investment will have reverberations for years to come by reducing economic growth. Of course, Keynesians project a government multiplier greater than one. Paul Klugman is an extreme case and thinks that the multiplier is even larger. But of course Klugman gives the Nobel Prize in economics as bad a name as Al Gore gives the Nobel peace prize.It is said that the Obama package assumes a multiplier of 1.5.  Interesting though is that research by members of the Obama team find a multiplier of 1 not 1.5.  That means that when the government spends one dollar that GDP increases by one dollar not one dollar and fifty cents. What is closer to the truth? Robert Barro writing in the Wall Street Journal states that his research shows a government wartime multiplier of around 0.8. This implies that a peacetime multiplier will be less. How much less? Try a multiplier of zero. Well I am man enough to admit I might have been wrong. In the face of this evidence I will revise my view of the government multiplier from negative to zero. The important question is whether Obama is man enough to do the same.


Jess said...

I have to say I am confused and disturbed about a lot of the items in Obama's stimulus package.

One, --- Why did he wait until yesterday to meet with leaders in the business community? It would have been helpful to have their input when the plan was being detailed.

Two, --- With this TARP funding, why doesn't he pick someone from the business community to oversee the execution? After all, the funding is not going to oversee itself and the Commerce Secretary does not have the adequate amount of time to devote to overseeing the funds.

Three --- Why do commentators keep saying that the major stimulant component of Obama's plan is the increases in Medicare, unemployment benefits, and food stamps? None of these things stimulates the economy. People in these positions will simply spend any extra money on PAYING BILLS -> which results in no job creation and does not increase the velocity of money.
The news media needs to invest in some people w/actual knowledge of how financial markets work!

David J. Moore, Ph.D. said...

First I am in agreement that government stimulus does not seem to be effective in promoting long term growth. It failed when George W. Bush tried it TWICE. From what I read in the macro literature, particular the work of Schumpeter, is that long term growth is driven by technological progress.

I was not even a twinkle in my Dad's eye during the depression, but, I did speak with a lady the other day who was alive then. She mentioned things did not get better until the war spending got going. I am not suggesting we need a (another) war. I am suggesting that the technological advances associated with the war time spending was the true driver of long-run growth.

I believe a stimulus package focused on technological progress can work. Packages that mail out $300 checks (Bush) followed by $600 checks (Bush) and packages that improve water parks in New Jersey (Obama) did and will do absolutely squat.

As an example, I for one am tired of seeing the same old tired gasoline powered engine that gets about 28 miles per gallon and pollutes our environment. How many billion would it cost (and how many jobs would it create) to have, say, state-owned (at the start) hydrogen stations built across the country? Could the U.S. become the leader in hydrogen-powered transportation? If not, what about some other "clean energy" or biomedical, or something!