Lately everyone is blogging multipliers. It is frequently suggested that the multiplier today is best estimated at 1.5 or 1.6. My point today is this: if you postulate a potent multiplier you cannot easily also postulate a liquidity trap. The whole point of the multiplier is that if the government buys cement from my company (say for a road) I as the company owner take those cash receipts and spend them elsewhere. Maybe so but that means people are willing to spend cash when they receive it. It means that a helicopter drop (and maybe other forms of monetary policy as well) would stimulate AD quite readily and for free. You don't need exotic or balance sheet-distorting QE here, a simple injection of cash will do.
Indeed, the Christiano, Eichenbaum, and Rebelo model of fiscal policy in a liquidity trap, no matter what you think of it (e.g., I am not sure that the derivation of equations 2.19 and 2.20 takes the non-smooth, black hole properties of the liquidity trap assumption seriously enough; also the critical p.13 sentence about how the MU of consumption rises with employment is the kind of Minnesota macro that Krugman justly complains about) both implies and states that monetary policy will work too. And if that monetary policy is truly a free lunch in terms of gdp, it should be quite credible (if it's not credible in the real world maybe the problem wasn't AD in the first place).
There are other models in which fiscal policy has a potent multiplier yet there is a liquidity trap. For instance fiscal policy may be a "sunspot" which gets you out of the liquidity trap. I have at least two objections. First, these models are question-begging. (Might not monetary policy be the sunspot? Why is fiscal policy the sunspot if indeed fiscal policy would otherwise not have much of a multiplier?) Second, no one much believed these models ex ante, before the current set of policy debates came along.
I am also puzzled by Paul Krugman's point:
…this [Barro's paper] tells us very little about what would happen under current
conditions: during World War II there, um, was a war on: consumption
goods were rationed, construction required special permits, and so on.
The government was, in other words, deliberately suppressing private
spending, through direct controls. So WWII is not a useful data point
for determining what the multiplier is under other conditions.
As I view it, during the war the government suppressed private spending because the government did not in fact believe there was much of a multiplier (at least at those margins). The suppression of private spending was not an exogenous accident but rather it reflected the very real trade-offs which had to be faced between guns and butter. At the beginning of the war unemployment was still quite high yet rationing came quickly, not only after full employment was restored, precisely because the trade-offs were faced quickly. Are we to believe that without rationing U.S. private consumption would have risen during WWII? Something like the following can be argued: "there is a multiplier for small acts of public investment but at some margin, such as we faced in WWII, that multiplier goes away for sufficiently large acts of public investment." I don't read Krugman as making that claim, but it would be his best available response to Barro.
“Maybe so but that means people are willing to spend cash when they receive it”
Does it matter how cash is received and which people are receiving it? What are the differences between fiscal and monetary stimulus, in these regards? If there are significant differences, you aren’t on solid ground when you argue that “being willing to spend cash” is a necessary condition for both forms of stimulus, and independent of either.
Perhaps the nature of recessions is such that people are more willing to spend stimulus cash when it arrives via the channel of fiscal stimulus than via monetary stimulus.
How does cash end up in people’s hands in each case?
But if they’re not willing to spend cash when it’s a check directly sent to them (like last year), why would they spend it when it comes from other means?
Honestly, I’ll admit I’m still confused about the concept of spending multipliers in general. I get how printing an extra $100 can have a multiplier, but if you take 100 dollars from person A via taxes and then give it to person B, such as by paying them to build a bridge, it doesn’t seem like you would affect anything, except for determining if the value of the bridge built was worth the transaction costs and that of whatever person A would’ve bought. But those are questions of the value of those items, not multipliers — I think?
This isn’t an ideological rhetorical question — I don’t understand how these three scenarios: a) not having a $100 tax in the first place, b) a $100 tax break and c) a $100 spending project — are different in this context.
Well, with the exception of the expectations argument that Luis mentions, but I feel like I would be wrong in attributing the entire impact to that. Can someone clear me up?
John
Well I don’t know, I’m just asking. But the question is motivated by the possibility that perhaps fiscal stimulus works by giving firms orders they otherwise wouldn’t have, and individuals jobs they otherwise wouldn’t have, and perhaps there’s a difference in the aggregate response when people holding on to their jobs and firms revenues holding up, than there is to everybody getting a cheque. I know the difference in my behaviour, relative to the counterfactual, arising from me either retaining or losing my job would be different from me either receiving or not receiving a cheque. The effects on expectations may differ, relatedly.
Morten (and Arnold), it is entirely acceptable to argue “There is a liquidity trap, therefore fiscal policy is better than a helicopter drop of money.” The problem is when you combine that with the claim that the multiplier is potent.
Disclaimer: I am a micro guy.
Regarding the WWII example, does it matter that the government was rationing capital and raw materials and not labor. Doesn’t this suggest that labor was not able to serve as a substitute for a car factory or aluminum? Isn’t the argument of Barro suggesting there was excess labor and therefore no reason for a trade-off ignore other constraints on production? (our current situation would be excess labor and capital)
A government policy that explicitly prevents production of cars (due to taking over factories) in order to produce Jeeps and tanks will force a trade-off and reduce the multiplier.
Is Barro guilty of the broader sins of the profession of not considering real world issues (and therefore ceterus paribus is a horrible assumption)?
What about the notion that when you send people to serve overseas in the military, while they were being paid, does the fact that they are not able to make purchases in the U.S. effect the possible multiplier effect? I would need to see the % of people overseas to see if it is reasonable to think that this would be of a large enough magnitude to matter.
A final point, as productive workers join the military and less skilled workers replace them (no offense to Rosie the Riveter intended) wouldn’t we expect overall productivity to fall as well?
I think the important thing people are forgetting (or neglecting) is that Barro had 5 different estimates for the defense spending multipliers. Barro included one starting from 1950, with a defense multiplier of .77.
So, even if you wish to reject his multiplier estimates prior to WWII due to the war economy, no reason has been given to reject his post-1950 estimates.
I agree with Tyler. If people want to pay down debt on assets or pay off assents (essentially saving) why is it not better to give the people holding the debt the money. This could be done through something like a suspension of FICA collection. Now if we need bridges and roads by all means lets build them now while financing and labor are cheap but beyond that lets let the people decide what they value.
how can tax and spend have a multiplier larger than 1? That makes no sense, you are taking away from someone to give to someone else.
Also, every time you use deficit for a stimulus you will need a bigger deficit stimulus later, because deficit spending is taking from the future taxes to pay for nowdays taxes. So every time you use deficit stimulus you increase the amount of money that must go to pay interest (and principle) on the national debt. So whenever you use deficit stimulus you are stimulating the now and reducing future growth potential and future stimulus potential.
This is dangerous.
As for whether the non-defense multiplier is smaller or larger than the defense multplier, Barro discusses this in his paper by pointing to the paper he authored with RG King (“Time Separable Preferences and Intertemporal-Substitution Models of Business Cycles,” QJE [1984]).
Barro states that to the extent in which government purchases is temporary has no impact on the size of the multiplier. Krugman would quibble with this condition, no doubt. Marginal income-tax rates were hold constant for purposes of analysis, however.
Nevertheless, Barro does relax the assumptions of his QJE paper, by obviating the condition of lump-sum taxes. With this, the government’s incentive to tax-smooth implies that tax rates will rise less when spending is temporary. Therefore, temporary (or wartime spending) tends to have a larger effect on real GDP than an equal-size permanent change. In short, in a world of distortionary taxes, temporary changes in government procurements have a larger effect on GDP since taxes do not rise equally with the temporary change.
In addition, Barro hypothesized that labor supply would be shifted outward due to war-time patriotism, and that command-and-control measures would make real GDP more responsive to government purchases.
The Barro-Redlick paper is a tightly argued paper with fairly good reasons for variations. Barro’s WSJ article betrayed the lucidity of his paper, which was unfortunate, since it was essentially a rehash of his other op-eds.
In WW II while real gdp grew rapidly, the actual real gdp available for civilian consumption contracted sharply (real gdp less military spending). So you had an environment where people had lots of income but nothing to spend it on. That is a very different situation than in a recession/depression where you have plenty of goods but no income.
I don’t understand this comment at all. A liquidity trap means a perfectly elastic LM curve over some region. Fiscal policy shifts the IS curve to the right. Over the region in which the LM curve is elastic the fiscal expansion leads to a multiplier effect with no increase in interest rates. So for small fiscal expansions there is no need for any monetary transactions. If you accept the idea of the liquidity trap you can have a large multiplier without any monetary policy. I am not sure what you can be referring to in this post.
Indeed, you’re right, we shouldn’t count out the possibility that Barro is giving FDR’s Administration far too much credit for their economic management. Perhaps FDR just needlessly destroyed consumption, and we could have had the same war effort but enjoyed more consumption. But there are estimates that start post-WWII.
During WW2, financial crowdout was quite likely, i.e. war bonds were replacing other assets or raising savings, so I can’t see why the multiplier in this period should be greater than zero (except due to revenue effect, i.e. people want butter despite the government wanting cannons and therefore work more to get it)
Barkley, it is easy enough to do a helicopter drop. Do it like food stamps, or for that matter through the food stamps program, if you wish.
Well, there is indeed a surfeit of studies and estimates that Menzie Chinn and others have summarized
in recent days on various blogs. Chinn shows a set with ranges up to 1.5-1.6. Those assume a fixed
exchange rate, which we do not have. However, the argument of those who say those numbers are still
about right for the US is that the mechanism by which a flexible rate lowers the multiplier is
through rising interest rates. But, with the Fed holding interest rates down, at least for now,
the fiscal policy is having its full effect as if we were in a fixed rate world (and indeed, the
mild decline of the dollar probably adds to the stimulative impact, against the model predictions,
again, as long as interest rates are held down).
So, anyone who wants to go along with Barro’s irrelevant empirical estimates based on WW II or his
“carefully argued” but theoretical paper from 1984, should consider carefully how to counter the
arguments put forward by the folks arguing for values around 1.5-1.6. Barro does not begin to
counter these arguments, although they may have their problems. (Oh, and anyone arguing for
“crowding out” in an economy with a 9.8% unemployment rate really needs to have their head
examined, sorry to be so blunt, but really.)
Rationing in war time is not about the economics of production, but about the equity of sacrifice.
How can a society draft some citizens and send them to war with all the deprivation that entails (and the odds of dying weren’t really that high) while those who aren’t drafted because they control the capital or have special skills in great demand are paid richly and then live richly, profiting from the war and the suffering of others?
And let’s be honest, war is normally fought to preserve the wealth of the rich and the lives of the powerful. If it isn’t fought to preserve their wealth and power, its fought to be reverse their exploitation of the poor. If the poor are going to fight to protect the rich, the poor need to believe the rich aren’t profiting from the sacrifice of the poor.
FDR wasn’t interested in paying the poor who had gone to war in WWI, but those who had sacrificed in WWI saw the rich who had profited from WWI living high in the 20s while most people struggled, and then the depression hits, and now the rich were taking their farms and jobs. FDR was convinced by advisers he needed to prevent a class war to save capitalism.
Rationing was required to save free market capitalism in order to eliminate the profiteering that war normally produces when the poor are sent to suffer and sometimes die in large numbers.
I think, in this international economy, not all spending results in the same domestic multiplier.
If you give me a $1500 tax cut, I may go out and buy a Korean LCD 52 inch TV. Other than Best Buy, who is the domestic recipient; and does LG (the maker of the monitor) buy its parts from the Korean economy, China, or elsewhere.
Just as the marginal propensity to save may alter a multiplier based on the recipient, the multiplier may also be affected by who is the recipient, and what the recipient purchases.
Thus, infrastructure purchases (roads, etc) or education assistance may have a different multiplier effect than a general tax cut.
We should be able to see this in looking at the Bush stimulus tax cut in 2007-8(?) and the current stimulus program. But, no one seems to be looking at the Bush stimulus tax cut and commenting on its effect. Probably because it stimulated my purchase of a LCD TV.
Re: Morten 1:10:04
Why does the multiplier for the cement order have to be small when short-term interest rates are near 0%? If the cement factory was idle (recession), then receives a government contract to produce cement, the owner has to spend most of the cash on labor and materials to produce the cement. Those workers and suppliers similarly spend much of the cash… repeat and you get a multiplier.
If the same idle cement factory owner is given a low interest loan, or helicopter drops cash in his lap, he doesn’t need to spend it, particularly if he doesn’t see future orders coming in. No multiplier.
I both cases, the cash comes from risk-averse investors who want to hold low interest government bonds.
Tyler,
Certainly food stamps or something like that are ways to do directed “helicopter drops.” But would
not something like that be fiscal rather than monetary policy?
Here’s my take on this issue:
What is seen as conspicuous consumption during years without wars, can be seen as treason during a war. Shared Sacrifice is an important concept during wartime. This is what bothered many people about the current wars, i.e., there didn’t seem to be any sense of shared sacrifice.
Also, if you remember Pres. Bush calling for spending as usual, presumably that was because war can alter expectations and consumption/spending patterns, and he was trying to counteract that possibility.
Finally, govt spending on infrastructure is justified as one part of a stimulus plan because it shows govt planning for the future, hiring workers, and providing much needed common goods. It is best viewed as an aid to QE, that helps signal recovery and inflation ahead. In that sense, it is the borrowing that is the real stimulus.
I actually agree with Barro about tax cuts and incentives, but infrastructure, as part of a total plan, does make sense. I have to say that the multiplier effect seems conditional on the premises used. My point is, again, that it makes sense as part of a borrowing/spending plan during a downturn. But I still think that the infrastructure projects should be self-justified and efficiently run. I don’t buy the idea of just spending for the sake of spending.
The lack of historical knowledge in this post is, with all due respect, pretty sad. Rationing was introduced in WW II for two reasons: military control of productive assets, and civilian harmony and fairness. There was plenty of gasoline, but rubber for jeep tires was unavailable at any price. As for life on the home front many uncontrolled prices did rise significantly – as a society we just felt differently than we do today about gold star mothers (those who had a son die in the war) being priced out of the market for meat or milk because Joe, down the street, had plenty of money from his high wartime wages.
Unless the new/repaired road leads to new offices or factories, at best you are just maintaining the road. There is no real gain. You are just keeping up with depreciation.
There are all sorts of multiplier models that rest on a ceteris paribus assumption. Their range of multiplier values must be understood in that light. But determining the value of a multiplier from ex poste experience is a difficult econometric problem. What was the context? A war? WW II? And what is the sample size on that kind of scenario?
Real interest rates remain very high. If you are investing in real estate in a depreciating market the real interest rate remains high. Few have an incentive to invest in housing given current market conditions.
Next the wealth effect of the stock market drop has also reduce the desire of households to spend. This may be made worse because the baby boomer generation is approaching retirement. In general that means large expenditures like autos will be delayed.
Milton Friedman argued that permanent income is the primary determinant of money demand. But what happens if people think that their future income is at risk? Is the money demand function stable or have we seen a big drop in velocity due to a drop in permanent income?
Or is Keynes right because low interest rates decreases money velocity because the real rate of return of a can full of buried money has turned positive?
If people see no good investment opportunities (outside of emerging markets) what happens?
If an anti-market Federal government is getting ready to impose heavy taxes on the economy (direct or through regulations) doesn’t that both have a negative wealth effect and reduce investment opportunities?
Keynesian spending may have positive impact on the economy but what if people, especially investors, view it as a temporary boost in spending and a long term drop in income because of the tax burden. The multiplier could be very small.
What if investors decide that the net impact of an anti-market Federal government is that the long run aggregate supply curve shifts to the left. The Reagan warning that an over taxed and over regulated economy reduces it’s productive potential?
We were hit with a negative supply shock (oil Prices) and then a negative demand shock (financial markets). You had a shift of the short run AS curve to the left, followed by the AD curve shifting to the left. We are left with much lower output and a lower price level.
We could buy foreign currencies, devalue the dollar by increasing the money supply, accept that bank lending will remain tight (banks are not going to increase lending while asset prices are falling and the net worth of firms are falling).
If you wanted fiscal policy I would reduce payroll taxes and buy up blighted urban areas for conversion into park space. An urban CCC.
The biggest thing we should do is create a culture to encourages profits, opportunity and growth. Not the insane anti-market crowd currently in Washington. Because when all is said and done, if we have a government that is anti-markets no amount of monetary or fiscal policy will help us.
Luis,
It was Tyler who brought up helicopter drops of money to people on food stamps, not me. I was critiquing the idea that monetary policy works like helicopter drops, and Tyler has not really answered that, as this food stamp scheme is fiscal policy in my book.
I would prefer productive infrastructure spending or aid to states to help them balance their budgets (and they buy goods and services mostly, not lots of transfers). Never a fan of the dig holes in the ground to refill them, although if one is going to do a helicopter drop, aiming it at poorer people would be preferable, which the food stamp scheme would do.
There’s a semantic disagreement between the author and Barkley Rosser about what constitutes fiscal and monetary policy. I happen to agree completely with Barkley: a helicopter drop would be a form of fiscal policy. But ultimately semantics don’t matter. When people say, “Monetary policy is ineffective in a liquidity trap,” they are referring to the policy of using newly created money to buy assets. If one wants to define “monetary policy” to include helicopter drops, then of course it can be effective in a liquidity trap. (In fact, even if the multiplier is very small, a sufficiently large helicopter drop will increase nominal national income.)
I don’t think there is any disagreement on the substance. Keynesians believe that the multiplier is greater than one and that monetary policy in a liquidity trap can only be effective if it is used to create new nominal wealth directly. There may be other arguments on the relative merits of helicopter drops versus conventional fiscal policy, but not Paul Krugman, Christina Romer, or any other of the pro-multiplier people will deny that a helicopter drop would be effective in raising national income.
If you count Federal Emergency Relief workers as employed (they would be considered so today according to current BLS definitions: wage received for work done) then unemployment wasn’t really that high at the start of WW II. The unemployment rate was 6.0% in 1941 and fell to 3.1% in 1942 (4th edition Historical Statistics of the United States). My impression is there was a lot less slack in labor and physical capital when WW II started than most people believe.
Fiscal multipliers are dependent on the size of the output gap, as even Barro’s paper concludes. Barro’s paper estimates the defense spending multiplier. The biggest boosts in defense spending during the period covered by Barro (1912-2006) occurred during WW I, WW II, the Korean War and the Vietnam War. Actual GDP exceeded potential GDP throughout both of the latter two wars. Similarly unemployment was very low throughout both world wars. Given this I’m surprised that Barro’s estimates were as high as they were.
Andy H.,
Well, it does get a bit fuzzy here. I would say money directed at poor people through food stamps, which would not involve literal helicopters, would be fiscal policy. However, if one were to take old Uncle Miltie literally, and the Fed were to go an print a bunch of extra paper money and then in fact hired helicopters to go around randomly dropping it from the air on various population centers, that would be monetary policy. Why I critiqued that in the first place was very simply that despite all the language about “helicopter drops” and monetary policy, we are never actually going to see anything like that. Real monetary policy goes through the banking system.
floccina,
Obviously if people “want to pay down debts,” this means they will save more of whatever extra income gets sent their way by whatever means, and this will lower whatever multipliers there are.
I don’t understand why the money hoarding associated with a liquidity trap is inconsistent with the multipliers talked about.
Let me work through an example:
* Government buys a value of cement. Unless there is excess demand for cement (which we assume there is not because we are in a recession, not operating at the Pareto frontier), the price of cement remains the same and GDP goes up by the value of the cement purchase. This gives a minimum multiplier of 1 from the fiscal expenditure.
* The cement producer now has greater income. The producer has a certain preference to hold this income as cash rather than spend or investment it. I think Tyler’s point is that, to be consistent with an economy in a liquidity trap, we should assume this preference is high.
Let’s assume a simple fraction of all income is hoarded as cash. If we think the multiplier is 1.5 what fraction of income has to be hoarded as consistent?
The geometric series sums to 0.5 at infinity:
1/(1-r) -1 = 0.5 -> r=1/3
Hoarding is the inverse of r, so with a multiplier of 1.5, we are assuming 2/3 of all income will be hoarded as cash. This seems enough high to me to be consistent with a liquidity trap.
The problem with monetary policy at the zero-bound is that there is no incentive for people to invest rather than hold cash – bonds and money become interchangeable, both zero interest investments. As we push monetary policy we are thus increasing money hoarding even as we increase money supply.
DanC,
There is nothing inconsistent in simultaneously arguing that WW II spending fully pulled us out of the remants of the GD, but the multipliers were small. We are talking about a massive fiscal stimulus an order of magnitude larger than what is going on now or that anybody is proposing for now. Keep in mind that in 1944 the budget deficit was equal to something like 40% of GDP. We went to overfull employment where absolutely crowding out was going on, quite aside from the impact of rationing, whatever its original motive (most of the discussion of that here being utterly irrelevant to the argument).
Anything to do with the difference between the psychological effects of job security on spending flows of people?
If one option is giving people cash but letting them be unemployed and the other option is fiscal stimulus which ensures they keep a job down, perhaps some people are more willing to consume merely because of the fact that they have a job.
Barkley
I guess we can agree to disagree.
I read Barro as arguing that a cut in marginal tax rates will increase real GDP and that the evidence for a strong government spending multiplier is lacking. Even during periods of massive government expenditures, wartime, the economy just reallocated resources and borrowed from the future.
Why shouldn’t we just assume that this is what stimulus spending typically does, reallocate resources and bills you later? Or even if the return is slightly positive, marginal tax rate cuts are more powerful.
Or as Barro has argued what we really need is pro-growth policies to encourage real long term growth.
My view
If you are in a liquidity trap, which I doubt, you might prefer stimulus spending. If you have had a perceived drop in permanent income, then the wealth effect of tax cuts can have a bigger impact.
I have never seen a demographic study on the “liquidity” problem in Japan. ie You had an older population that saw a big drop in the value of assets in Japan. Did this wealth effect on an older population, a perceived drop in permanent income, cause the troubles. Stimulus spending on public projects could not stimulate the economy. Why? Is it because temporary spending today, payed with higher taxes tomorrow, does not make a large part of the population, the investor class, feel any wealthier? They just react the way you would expect, they reduce consumption.
The wealth impact of the drop in the value of assets held by aging baby boomers in this country maybe having a greater impact on the economy then many realize. If I were looking for a research project, I wonder how a country’s demographics affect the impact of stimulus spending.
DanC,
And if you are going to continue to cite Barro as if he is somebody who actually knows what is going
on or what should be done about it, what is his explanation of how we got to where we are now? Last
time I checked, he has none, and that is because for him all downturns are due to “exogenous shocks.”
What was the exogenous shock that gave us the housing bubble?
Also, people want to give him a Nobel Prize for his famous “Ricardian Equivalence,” which lies behind
a bunch of the arguments he is making now. But, let me remind you that when Reagan cut tax rates,
the savings rate went down rather than up as Barro’s model forecast. We are supposed to take his stuff
seriously? Excuse me.
@Barkley Rosser,
I find your comments very refreshing. They reflect a thinking largely in agreement with my own. I have a couple of points I would like to add to what you have said most recently:
1) Ricardian Equivalence is for the most part not supported by the empirical evidence:
“There is little evidence of direct crowding out or crowding out through interest rates and the exchange rate. Nor does full Ricardian equivalence or significant partial Ricardian offset get much support from the evidence.”
http://www.imf.org/external/pubs/ft/wp/2002/wp02208.pdf
2) I’ve often wondered why public debt should be such a problem for the economy. The period from 1948-1973 should always be pointed to in that regard. I have book entitled “The Great Leap” that points out the quantum leap in living standards during the period (real GDP per capita growth averaged 2.5%). The country seemed to benefit from a larger than usual amount of total debt being “public” (the opposite of our own time period).
Isn’t the argument of Barro suggesting there was excess labor and therefore no reason for a trade-off ignore other constraints on production? (our current situation would be excess labor and capital)
How could there have been excess labor when the unemployment rate dropped to near zero even with pulling additional people (i.e. women) into the labor force?
Barro didn’ say the multiplier was zero from WWII but that it was less than one. This makes sense to me. When an economy is far below full employment, the multiplier is more potent. As it appraoches full employment, it falls until it hits zero or even negative.
The suppression of private spending was not an exogenous accident but rather it reflected the very real trade-offs which had to be faced between guns and butter. At the beginning of the war unemployment was still quite high yet rationing came quickly, not only after full employment was restored, precisely because the trade-offs were faced quickly.
Did rationing come quickly because we were experiencing trade offs at the start of the war or did it come quickly because policy makers knew from experiences in WWI and the Civil War that certain products like fuel and steel were not able to be produced in sufficient quantities by the economy to both fight a war and supply unchecked consumer demand?
Are we to believe that without rationing U.S. private consumption would have risen during WWII?
I think it almost certainly would have until we achieved full employment and then the gov’t would essentially fall into a bidding war with the economy. Correct me if I’m wrong but didn’t this happen in the Civil War where the gov’t didn’t directly control the industrial economy but ended up resorting to inflation in order to divert resources to the war effort.
Something like the following can be argued: “there is a multiplier for small acts of public investment but at some margin, such as we faced in WWII, that multiplier goes away for sufficiently large acts of public investment.” I don’t read Krugman as making that claim, but it would be his best available response to Barro.
Well duh, if it wasn’t this way then you have a totally free lunch. You could stimuluate to infinity and receive infinity plus one in return forever. Only supply siders, though, think that way. Krugman, Keynes, etc. all work in a framework where as you approach full employment stimulus becomes less and less effective.
The French tried to control the price of bread during the early years of the Revolution, and it ended up with disastrous consequences. Similarly so with the Soviets and various agricultural products.
It’s pretty good.
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