2010 April 07 Wednesday
Robert Barro Skeptical On Fiscal Stimulus Benefits

Harvard economist Robert Barro is skeptical that government spending provides a big stimulus to the economy.

In terms of the stuff that’s not wartime spending – which we’re probably most interested in in the current climate –it’s just hard to know from the history of the data and the time series. The New Deal is part of my research, and it’s bigger than the other non-defence expenditure in terms of stimulus, but it’s not enough to really sort it out.

So I don’t think you can reliably say what the effect is. But conceptually you’d expect the wartime spending to have a bigger effect for various reasons on the GDP than the equivalent amount of expenditure in a non-war situation. And the wartime effect you can estimate pretty precisely, and the multiplier is clearly less than one, even in World War Two – it’s in the order of 0.6, 0.7, something like that.

So your point is that even in the context of massive expenditures in a wartime situation, the multiplier effect of government spending on the economy is less than one – ie, it is not a multiplier at all. In other words, fiscal stimulus does not work. I read your WSJ editorial on this. Is that a good way for the layman to understand your arguments? Also this, on the “Voodoo Multipliers" and your September 2009 NBER working paper (most recent version available on the left)?

Yes, those articles refer to this kind of evidence, and I’ve been working more on it, trying to make it more precise. Some economists have argued that in a time of slack the multiple should be bigger, because there’s more capacity to respond to the extra demand. There’s a little bit of evidence that that’s right. A lot of that comes from the build-up in World War Two, because in 1941 the unemployment rate is still around nine per cent, so you can see what is the effect in that environment, in a high unemployment situation, of having a big expenditure increase. (Later in the war, the unemployment rate is close to nothing, so you don’t have that setting.) There’s a little bit of evidence from that that the multiplier is bigger when there’s more slack. But it doesn’t look like the multiplier gets up to one, even when the unemployment rate is nine per cent. It’s getting closer to that, but even then it is not one.

So the United States and some other countries are going deeper into debt in order to lessen the depth and length of the current economic downturn. But all that debt which will burden us in the future isn't delivering much benefit today.

Obama's economic advisers see government as more efficacious when it comes to boosting the economy. Barro thinks the evidence doesn't support their optimistic pronouncements.

And yet neo-Keynesians – which include White House economics adviser Christina Romer – often cite the number as being 1.5, and you say in your article that the Obama administration is using 1.5 as a basis for its fiscal stimulus policies. How do they come up with that then?

Oh they pulled that out of the air. I have the advantage of having at least a little bit of empirical evidence: as I said, it’s based particularly on military purchases. So even though that evidence is not that great, it’s infinitely better than the alternatives, which are no evidence. I think Valerie Ramey’s work is the best in terms of empirically trying to figure what the effect is of expenditure on the macro-variables. She has focused mostly on the post-World War Two period, but she’s looked somewhat at the earlier part.

I see a few of motives for why politicians support fiscal stimulus. First off, politicians can use stimulus packages as pork. Hand out goodies to favored constituencies. Second, during a recession politicians want to be seen as doing something to respond to the pain of their constituents. Third, politicians, especially on the political left, want to believe that government is an agent of positive change. All these factors make them choose economic advisers who look at the evidence of economic history with a bias toward finding benefits from fiscal stimulus.

The problem is that America can't afford to pile up more debts. We are headed toward a sovereign debt crisis.

Share |      By Randall Parker at 2010 April 07 09:16 PM  Economics Government Intervention

Edward Thwaite said at April 8, 2010 10:23 AM:

"... the multiplier effect of government spending on the economy is less than one ..." According to Milton Friedman, government does not create jobs - at best, it transfers jobs from one sector of the economy to another. If government provides the basics of legal order and infrastructure, then past that point is all government spending likely to be either transfer or waste of wealth? In calculating the so-called multiplier effect is the crucial issue likely to be the accounting procedures for government debt obligations? In the Enron scandal, we learned how SPEs (special purpose entities) can be outrageous frauds. Are government debts and ill-defined obligations now presented honestly? If the international market for US federal debt wobbles, then shall we witness painful days of true accounting procedures and harsh fiscal correctives?

Wolf-Dog said at April 8, 2010 8:36 PM:

It all depends on what kind of stimulus spending the government is doing...

If the government is merely subsidizing the oil companies and special interest groups according to the machinations of various lobbies, then the stimulus spending would be inefficient.

But if the government is surgically investing in incubator technology companies by means of special loans, by means of very aggressive tax cuts for research and development, then this is a different story. The Israeli government has a special incubator company spending system, and this has been very successful, since the growth rate of Israel is quite impressive.


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