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Saturday, January 10, 2009

More or Less

Greg Mankiw:

Is Government Spending Too Easy an Answer?, by N. Gregory Mankiw, Commentary, NY Times: When the Obama administration finally unveils its proposal to get the economy on the road to recovery, the centerpiece is likely to be a huge increase in government spending. But there are ample reasons to doubt whether this is what the economy needs. ... When debating increased spending to stimulate the economy, here are a few of the hard questions Congress should consider:

HOW MUCH BANG FOR EACH BUCK? Economics textbooks, including Mr. Samuelson’s and my own more recent contribution, teach that each dollar of government spending can increase the nation’s gross domestic product by more than a dollar. ... This ... is called the multiplier effect.

In practice, however, the multiplier for government spending is not very large. The best evidence ... estimates that each dollar of government spending increases the G.D.P. by ... 1.4 dollars. ...

WILL THE EXTRA SPENDING BE ON THINGS WE NEED? ...People don’t usually spend their money buying things they don’t want or need, so for private transactions,... inefficient spending is not much of a problem. But the same cannot always be said of the government. If the stimulus package takes the form of bridges to nowhere, a result could be economic expansion as measured by standard statistics but little increase in economic well-being.

The way to avoid this problem is a rigorous cost-benefit analysis of each government project. Such analysis is hard to do quickly...

HOW WILL IT ALL END? Over the last century, the largest increase in the size of the government occurred during the Great Depression and World War II. Even after these crises were over, they left a legacy of higher spending and taxes. ...

Rahm Emanuel, the incoming White House chief of staff, has said, “You don’t ever want to let a crisis go to waste: it’s an opportunity to do important things that you would otherwise avoid.”

What he has in mind is not entirely clear. One possibility is that he wants to use a temporary crisis as a pretense for engineering a permanent increase in the size and scope of the government. Believers in limited government have reason to be wary.

MIGHT TAX CUTS BE MORE POTENT? Textbook Keynesian theory says that tax cuts are less potent than spending increases for stimulating an economy. ...

The evidence, however, is hard to square with the theory. A recent study by Christina D. Romer and David H. Romer ... finds that ... the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases. ...

Christina Romer, incidentally, has been chosen as the chairwoman of the Council of Economic Advisers in the new administration. Perhaps this fact helps explain why, according to recent reports, tax cuts will be a larger piece of the Obama recovery plan than was previously expected.

All these questions should give Congress pause as it considers whether to increase spending to stimulate the economy. But don’t expect such qualms to stop the juggernaut. ...

I'm going to assume that Christina Romer is the best judge of her own research and how it applies to the present situation. Here's what she said today on this topic in a paper written with Jared Bernstein:

Appendix 1: Multipliers for Different Types of Spending

For the output effects of the recovery package, we started by averaging the multipliers for increases in government spending and tax cuts from a leading private forecasting firm and the Federal Reserve’s FRB/US model. The two sets of multipliers are similar and are broadly in line with other estimates. We considered multipliers for the case where the federal funds rate remains constant, rather than the usual case where the Federal Reserve raises the funds rate in response to fiscal expansion, on the grounds that the funds rate is likely to be at or near its lower bound of zero for the foreseeable future.

We applied these multipliers directly to the straightforward elements of the package, but made some adjustments for elements that take the form of transfers to the states and tax-based investment incentives. For transfers to the states, we assumed that 60% is used to prevent spending reductions, 30% is used to avoid tax increases, and the remainder is used to reduce the amount that states dip into rainy day funds. We assumed that these effects occur with a one quarter lag. For tax-based investment incentives, we used the rule of thumb that the output effects correspond to one-fourth of the effects of an increase in government spending with the same immediate revenue effects. This implies a fairly small effect from a given short-term revenue cost of the incentives. But, because much of the lost revenue is recovered in the long run, it implies a fairly substantial short-run impact for a given long-run revenue loss. We confess to considerable uncertainty about our choice of multipliers for this element of the package.

Output effects of a permanent stimulus of 1% of GDP (percent)
Quarter Gov. Exp Taxes
1 1.05 0.00
2 1.24 0.49
3 1.35 0.58
4 1.44 0.66
5 1.51 0.75
6 1.53 0.84
7 1.54 0.93
8 1.57 0.99
9 1.57 0.99
10 1.57 0.99
11 1.57 0.99
12 1.57 0.99
13 1.57 0.99
14 1.57 0.99
15 1.57 0.99
16 1.55 0.98

As to qualms about the attempt to increase output and employment with government spending, 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.

    Posted by on Saturday, January 10, 2009 at 08:56 PM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (34)


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