Confusions about the multiplier < 1 (me defending fiscal policy, sort of)

I've been having discussions with some associates about what it means when a measured short-run multiplier is positive yet less than one.  It is occasionally suggested that a multiplier less than one means that fiscal policy is necessarily a bad idea, but I don't see it that way. 

Keep in mind there is no a priori argument that the government purchases "don't count," even though sometimes they don't produce much value ex post.  And the borrowed dollar isn't "taken out" of the economy in a meaningful way.  It can come from abroad or it can accelerate velocity, at least potentially.

Let's say the multiplier is 1.0.  That typically means a dollar is spent on a road (or whatever), which is in the plus one column.  There is some crowding out of private investment but not usually one hundred percent.  Let's say that's minus 30 cents.  The spending on the road, and road workers, has some positive second-order effects.  Let's say those are plus thirty cents per dollar.

In that particular case, the multiplier ends up as equal to one and that is net, all things considered.  The spending still would yield a short-term positive for gdp if the multiplier were 0.5.

The case against fiscal policy should examine long-term budgetary costs, possible confidence factors, implementation lags, political economy problems, difficulties in targeting unemployed resources, and also the (underrated) notion that sometimes fiscal policy postpones problems into the medium run rather than solving them through jump-starting a recovery.  But it is difficult to deny that fiscal policy brings some economic benefits in the short run, or can brake an economic decline, even if the measured multiplier is less than one or for that matter well under one.  

As an aside, I do not prefer to emphasize the notion of "investment crowding out" for analyzing fiscal policy.  The notion is a coherent one, but frequently analysts, and audiences, end up confusing nominal flows of finance with real resource opportunity costs.  I instead prefer to ask how effectively the fiscal policy is targeting real unemployed resources and to deemphasize the financial angle, at least for the first-order analysis.

Comments

So I'm confused about this multiplier thing. It get's quoted as if it's sort of some fixed constant, without anyone ever asking what the money is being spent on. I.e. if the government pays someone not to work, then that's probably going to be have a long term negative effect, where as if the government pays someone to build a bridge or a road, that's probably going to have a pretty positive effect (assuming it's not, err, a bridge to nowhere). So surely the multiplier depends on *what* the government is doing

(following previous comment) It should be noted that the Keynesian conception of a multiplier revolves around aggregate demand, not the individual project costs and benefits (recall the story about employing people to dig a hole and fill it back up). This is why unemployment benefits have high multipliers - at a micro level they encourage less work, but the idea is to put unemployed resources elsewhere back to work.

Is the concept of a multiplier in decision making even valid? Doesn't it require essentially the knowledge of the future before it happens.

Take for example public investment in copper telephone networks, did anyone envisage that this would lead to the subsequent creation of the internet. If you were trying to calculate a multiplier based on that initial network investment how would you know what to measure?

That's one dollar of resources bid away from value creation in the world of exchanged goods -- including demand for goods by labor.

Thinking non-economically, "macroeconomists" never think of that.

"Let's say the multiplier is 1.0.  That typically means a dollar is spent on a road (or whatever), which is in the plus one column.  There is some crowding out of private investment but not usually one hundred percent.  Let's say that's minus 30 cents."

This seems unnecessarily confusing. Aren't you just trying to say that a multiplier less than 1 but greater than zero still means a net gain of output?

You say that you should focus on targeting unemployed resources. I think this is absolutely correct, but when has a stimulus met this test? The DeLong/Krugman axis thinks that any spending at all is good -- are they as completely wrong as I think they are?

Let's put that in alternative words.

You will have remade all of economic science if by shear magic an entity merely because it is called "government" can turn a non-economic good into an economic good -- merely by the act of an economist or blogger verbally labeling something as "real unemployed resources".

If word play could produce such transformations the alchemist by now would have filled the world with gold.

" I instead prefer to ask how effectively the fiscal policy is targeting real unemployed resources and to deemphasize the financial angle."

New money for additional government spending can come from one of four places: taxes, domestic borrowing, overseas borrowing, or creating the money out of thin air.

If the new spending is paid for by new taxes, the net effect is negative due to the deadweight losses of government.

If the new spending is paid for by domestic borrowing, there is still the same deadweight loss (as the money would have otherwise been invested in non-government activity, which would create demand domestically). There are also long-run negative effects, as the money not invested in productive capacity will lead to lower future growth.

If the new spending is paid for by money created out of nothing, the result is effectively the same as if it were paid for by a broad-based consumption tax, as the new money will raise prices across the board. Everything gets more expensive, so people not receiving the new money will generate less effective demand than before. There are deadweight losses with this method, also, and if repeated, inflationary expectations will create significant distortions and lead to slower future growth.

If the money is borrowed from abroad, it is possible to provide a short-term boost to the domestic economy, assuming that the money borrowed displaces investment in foreign capacity (or foreign governments), not investment in domestic private capacity. However, the long run cost is at least as bad as for domestic borrowing. Further, there's not a good way right now to induce foreigners but not domestic investors to buy government debt.

So no matter how the government does it, pretty much any new spending will actually shrink the economy, though if the money is borrowed from abroad, that shrinkage will be put off a little while. The only exception would be spending which has significant effects to increase productivity, such as public health spending, or a few other sorts, most of which problems are mostly solved in this country. (Third-world countries may benefit more, if the money is spent honestly and not stolen.)

Crowding out isn't that coherent as the economy moves from a low level of output during busts to a high level during booms. What happened to crowding out then? Now at a high level of output crowding out can occur, it is just there is wide swath of output levels that crowding out is not only invalid but that growth leads to crowding in. Redefining multipliers less than 1 to be 1 is just confusing, though the employment of real resources is the way to think about this but is it because prices are wrong or because they are right?

Why does it matter if the dollar spent "comes from abroad"?

If a non-American dollar holder has the choice of spending on an American good or service, investing in American assets, or lending to the US government, his choice of the latter is as much "taking out" a dollar from the economy as an American who faces the same choice.

MikeDC: you assume the US makes things the rest of the world wants, needs, or can afford.

Wall Street has been selling the world the idea the US makes money while leaving the making of goods to the rest of the world, and economists have been telling us that we Americans should stop making things and simply import them, and focus on ideas which make money.

It takes money to make money, so sending money to the US is the way to make money. The alternative isn't buying American - after all, Buy American is anti-American according to economists.

Lord: And the Miami construction industry underutilization can be fixed by injection of stimulus.

Please.

Derek

Maybe the blog should be renamed "Anti-marginalist Counter-Revolution" because Tyler here is counting value produced based on backward looking costs expended, rather than on relative valuations calulqated using forward looking future exchange valuations estimations.

"Let's say the multiplier is 1.0.  That typically means a dollar is spent on a road (or whatever), which is in the plus one column."

Gypsy Punk, in what sense did Tyler do any ass-kissing here? The only folks mentioned are "associates", who he is disagreeing with. Perhaps you mean in general, in which case you should start a blog in which you complain about the character of Tyler Cowen rather than posting on a comment thread where people are discussing what's on topic.

For Americans government spending is waste and private spending is best. It is clear that rabid and ignorant Americans are oblivious to the catalogue of govt expenditures that make for a CIVIL society from defense to education and on and on...it enables people to live a life compared to most of the world.
Look to your politicians who have been bought by the corporate interests who receive vast sums of taxpayers dollars (eg TARP) and receive bonuses!

Keynes was quite specific about his definition of a "multiplier". It was the incremental increase in income that resulted from an incremental increase in investment (Chapter 10, "General Theory of Employment, Interest & Money"). The value of a positive multiplier would be tied directly to the life of the asset being invested in. An invested dollar that generated an increase in income of 20 cents a year for ten years would be a pretty good outcome.

I don't recall Keynes saying much about a government spending multiplier. That seems a creation of those following him.

From what I can tell, there seems to be some confusion about income and government spending. Income derives from the succesful exchange of goods and services produced. The income generated can be consumed or invested: by the person creating the goods and services or government (which may tax income or borrow it). To increase next year's income, one must invest so as to increase the means to produce goods and services for next year. Simply shifting the spending of people's income to the government can not increase a nations income, period. It takes savings and investment to accomplish that.

Furthermore, one would be hard pressed to prove that borrowing a dollar from someone in China by the US government increases spending in the US. I suspect that person in China would unload that dollar in current goods and services or assets, if the US government wasn't trading our children's income for it. And if the Chinese are willing to trade their goods and services for little pieces of paper with Federal Reserve Note stamped on it, well that's a pretty good deal since it takes very few resource to print those things.

Perhaps those building all of these economic models should take a few accounting courses or learn a little bit more about the conservation of mass and energy (or income in this respect).

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