Fiscal policy can raise measured gdp without improving the economy
or human welfare. Take a polar case where there is zero crowding out
and there is one unemployed worker. Government taxes a rich man who is
initially hoarding liquidity and spends that money putting the
unemployed man to work.
Measured gdp goes up but is the new state of affairs better than the old?
Say the unemployed man had valued his leisure at 20K and was not
taking the previously available jobs for 19K. The government now pays
him 40K. For the new worker that is a gain of 20K in value but of
course the cash itself is a transfer and does not represent a net gain
from an economic point of view (though you may like the distributional
Let’s say the new public sector output is produced by labor only.
40K is spent to produce output which, in a market setting, would be
Put aside money flows. We have 20K more of output value and a 20K sacrifice of leisure value.
That’s no net gain, but measured gdp has risen by 40K. Note that
the contribution of the public sector to measured gdp doesn’t very
effectively measure true value added.
Introducing some crowding out makes fiscal policy look worse, as
would considered the deadweight loss from taxing the rich man. You
could make many other adjustments to the example; some would favor
fiscal policy, others would not. The most obvious adjustment to make
fiscal policy look good is to assume that the new output a valuable
public good. Or you might argue that the resulting spending multiplier
is higher than the real balance effect which results from the rich man
holding the money (lower prices for everyone else).
But keep this example in mind the next time you see a measured
empirical connection between fiscal policy and gdp. "Money spent" and
"gdp registered" are not the same as "value created."