Keynesianism, Multipliers and Stimulus

Lots of folks are piling on Russ Roberts but I want to focus on one thing he says here

I recently interviewed Valerie Ramey on the multiplier. In her work, the multiplier ranges from .8 to 1.2. A multiplier of 1 means there is no stimulus from the spending–GDP rises by the amount of the increase in G but by no more. Private spending doesn’t grow. When you include the taxes (either today or in the future to pay back debt from the increase in spending) that finance the government spending, it’s particularly costly.

I think this is substantively wrong. A multiplier of zero means there is no stimulus.

It might be easier to dispense with the term stimulus to see why.

A multiplier of zero implies complete crowding out of the private sector by government. The government spends more and the private sector offsets this exactly by spending less.

A multiplier between zero and one means that there is some crowding out by the private sector. The government spends more, the private sector spends less but not enough to offset government spending.

A multiplier of 1 would suggest no crowding out. The government spends more and private spending is unaffected on net.

A multiplier above one would suggest crowding-in. The government spends more and this increases private as well as public spending.

So now suppose the multiplier was one and invariant to the level of spending. Then the government could choose whatever level of unemployment it wanted without reducing the production of private goods.

That would mean that for example the government could have lowered the unemployment rate from in 2009 by two or three percentage points had it chosen a large enough expenditure [Added: with no loss of private production. This is vastly strong claim than simply we could assist in easing the pain]

As for the total cost, it depends in large part on whether you place any value on those expenditures. So if we are buying roads and schools, you may not believe that are as useful as private construction spending might be, but are they 100% useless?  If they are even only 50% useless then you have come out ahead.

How the borrowed funds affect the long run economy is complex and depends on what the monetary response is, in large part. However, note that the government does not ever have to pay the bonds back and in general does not even have to tax the population in order to service them.

That’s because when the recovery hits the interest rate on t-bills is less that than nominal growth rate.

So even rolling in the interest payments continually will result in a declining debt-to-GDP ratio. Eventually the debt will just shrink away.

A multiplier above one suggests that when the government spends more we get more government goods AND more private sector goods. There is crowding-in.

Here it makes sense to do spending even if the project you are spending on is worthless. This is digging ditches just to fill them back up again territory.

Now that having been said I think people worry too much about the multiplier.

I heard lots of people suggesting that we should do direct spending over tax cuts because the multiplier is bigger, but this is not the right way to think about it.

You have to consider the logistics of actually spending this money and the effect that its going to have on the economy.

If you have some project sitting on the shelf that you wanted to do anyway and it has lots of return then you should do that. Trying to assemble projects is going to be more difficult and the side-benefits are going to be less. Plus if the only reason you are doing this project is to lower unemployment then you have to consider the distorting effects it has on the economy.

One great thing about tax cuts is that they are really easy to implement and we don’t have to worry about trying to direct resources to some end.

People can direct resources to whatever end they want. We also get the benefit of being able to do a broad based stimulus that directly benefits lots of people at once.

People often think of tax cuts as being less progressive, but we could make them progressive by cutting taxes that poorer folks pay. So there is little reason to worry about that. Of course, if you don’t care about progressivity then you don’t even have to worry about this, you could cut upper marginal rates or something else.

There is much more to say here but this is really important

I hold my ideology for a wide range of reasons many of which are based on what I observe about the world and human behavior along with a set of beliefs about how the world would work if my ideology were more prominent in policy decisions. But I don’t pretend I’m against government spending because the multiplier is small.

Yes, but you can think the multiplier is small and still be a Keynesian. More importantly you can be against government spending and still be Keynesian.

What if you just hated the government? Say the government raped and killed your family and you still haven’t gotten over it. One could easily say, look I believe that sticky prices cause general disequilbrium and real effects from monetary shocks. I also recognize that when the central bank sets the interest rate on government debt that government borrowing is expansionary.

But, I’ll be damned if I want to hand over more power to the very people who destroyed everything I hold dear.

That’s thoroughly Keynesian and thoroughly anti-government.