The fiscal multiplier during World War II

WWII is viewed as the quintessential example of fiscal stimulus and exerts an outsized influence on fiscal multiplier estimates, but the wartime economy was highly unusual. I use newly-digitized contract data to construct a state-level panel on U.S. spending in WWII. I estimate a relative fiscal multiplier of 0.25, implying an aggregate multiplier of roughly 0.3. Conversion from civilian manufacturing to war production reduced the initial shock to economic activity because war production directly displaced civilian manufacturing. Saving and taxes account for 75% of the income generated by war spending, implying that the add-on effects from increased consumption were minimal.

That is from a 2018 paper by Gillian Brunet, and you will note that it reflects the consensus of the literature as a whole.  I do favor the federal government borrowing and spending a great deal of money right now on things that we need.  If you think we are in a traditional Keynesian scenario, or are pulling out a traditional AS-AD model, you are going to be very badly disappointed.  Most of all, we need to be spending more on public health and remedies for Covid-19.  Here is my earlier Bloomberg column on analogies and disanalogies between Covid-19 and World War II.  And again, see Garett Jones and Dan Rothschild on the 2009 stimulus.


GDP numbers during wartime are meaningless. GDP is supposed to be a measure of the market value of all the goods and services produced in a country. What’s the market value of a tank during World War II? All economies were command economies during World War II and lacked market prices that could be used to fairly measure GDP; thus wartime measures of GDP in the US should be treated with the same validity as Soviet GDP measures at that time. Notably, in 1946, US GDP fell by 12%, on par with the worst year of the Great Depression, yet 1946 was not remembered as a Great Depression but as a post-war boom. That’s because wartime GDP was artificially inflated through command economy accounting and had little relation to people’s actual standard of living.

Economist Robert Higgs would disagree, but actually wartime GDP numbers may be significant, precisely because it is a 'command-and-control' economy, where government takes up a good percentage of the economy. Hence, if when the government spends $1 in war and only gets a followup of 30 cents, it doesn't say much about Keynesian fiscal spending as a panacea, especially when they say fighting Covid-19 is like being in a war (think of all those empty shelves today). I think that was the point of TC's post.

"Hence, if when the government spends $1 in war and only gets a followup of 30 cents, it doesn't say much about Keynesian fiscal spending as a panacea, "

Hmmm, if the gov't spend $1 in war and got $0.30 aren't you really saying it purchased $1 in goods and services (say paying workers to build a top secret lab called the Manhatten Project) and GDP went up and additional $0.30 (say some workers having a bite to eat at a local diner)? $1.30 in more GDP for $1 in spending still in the positive.

If the gov't spent $1 but GDP only goes up $0.30 that would imply some overstimulus where the economy is already tapped out and the $1 in gov't spending is offsetting $0.70 in other spending because the economy simply has no unemployed resources to use.

GDP is a measure of the wealth of the economy - not specifically 'market value'.

The problem with using GDP measurements during wartime is that *government spending* is part of the GDP measurement. The US government could spend 20 trillion dollars buying tanks and immediately blowing them up. GDP goes up, we're all in the same place.

1. GDP is a flow variable, not a stock one. Wealth is a stock variable and is not measured by GDP. GDP is a measure of the goods and services the economy creates in a time period.

2. No government spending is not a problem in GDP calculation. Yes government could buy a lot of tanks and blow them up. That doesn't change the fact that the economy is what produces the tanks and producing tanks is a good. Some economies can produce a lot of tanks and others can't produce any.

1. Command economy or not doesn't matter. GDP is about the total goods and services produced in an economy. A tank is a good, it is produced, it is part of GDP even if it was built because of gov't fiat.

2. Tanks do, of course, matter. In WWII, ask Poland if they might have rather had some more tanks from their GDP?

3. The value of a tank to GDP is simply what was spent to produce that tank. This is how GDP is calculated and it's a somewhat amoral calculation. If you guy a gun because you like guns, that is added to GDP. If you buy a gun because there's been 50 home invasions on your block, that again is added to GDP even though it's not for reasons we'd like.

Omg do you actually believe this?

So we can maximize real GDP buy printing money and paying every American $1,000,000 a year and burn every building to the ground and destroy every piece of machinery. It’s a service produced by the government.

We’ll be rich !

Indeed. Put another way, how effective was WWII as a fiscal stimulus in Britain, France, and Germany?

Depends how far away was Britain, France and Germany from full employment when WWII broke out for them? The core concept here is if the economy is operating at its production function boundary, fiscal stimulus goes nowhere. You can only make a tank if you make less cars. If you're below it you get what feels like a free lunch, you can make the tank while still having the cars.

Of course it isn't really a free lunch but eliminating an opportunity cost. You're able to make that tank because you had some workers sitting around not working and/or a factory that had a production line idle.

If you paid every American $1M to burn every building to the ground nominal GDP would rise a lot. When Americans want to go buy stuff with their $1M, they would discover there's almost nothing to buy since every building is gone. Prices would go through the roof and Real GDP would clearly show a decline.

Likewise next year when there are no buildings, no capital the economy would not be able to produce much of any goods and services . Hence GDP would go to near zero.

How relevant is WWII when there were wage and price controls and government allocation of resources and the forced savings because there was nothing to purchase, not even nylon stockings. Maybe cigarettes.

Tyler, do you materially disagree with any of Paul Krugman’s takes on the situation, and if so, what particularly and why? Thanks.

The guy is wrong more than a broken clock. He Advised Enron during their collapse . . . and that was probably the high point of his career.

Most weather girls have a better take on the economy than Paul. He's like the Baghdad Bob of Economics.

Re: Enron

Disinformation from the Alt-Right never dies. But, the truth is an antidote to its dissemination. Krugman's explanation of his two paid for speeches below.

Krugman personifies how partisan politics undermines economics. Another great example is Jason Furman who as head of Obama’s Council of Economic Advisors predicted doom and gloom in December 2013 when Republicans refused to extend unemployment benefits and the “stimulus” welfare expansions. So Q1 2014 was the awful winter in which the economy contracted and then our strong economy started in Q2 2014. So extending unemployment too long clearly undermines the job market and economic growth which is common sense but liberal macroeconomists reject it because of partisan politics.

That should say “extending unemployment benefits” and not just “extending unemployment”.

“ These meetings were not about Enron business, nor were they about policy in areas closely related to Enron business; basically they were seminars on world affairs. ”. 50k for seminars about world affairs? And you believe that?

And why not? Big companies get guest speakers all the time. Do you think Enron wasn't sure how to run their business and said something like "Let's pay Paul Krugman to tell us, at an open employee event"? You're just jealous that no one pays you to hear what you have to say. Keep your comments up, perhaps one day you can at least get paid to be quiet.

He was on the advisory board.

I don’t hold it against him but he was selling his credibility.

If you write comments here (and give a speech), you are, in the same way, on the MR advisory board. Read the link I posted.

I am on the MR advisory board since I post comments here in the same way Krugman was on Enron's advisory board.

From the materials I cited: "So what was my relationship with Enron? I was offered a $50,000 fee for a year's participation in the advisory board, which would entail attending and presenting at two meetings, each of which would extend over two days."

Do you give seminars on world affairs, not talk about the business, and get $50k in 1999 dollars?

All the time. And, I am on the advisory board of MR since I write comments here in the same way those other academics who gave corporate speeches were on the advisory board.

Really funny.

Prestigious companies love to hear presentations on world affairs. They, after all, like to think of themselves as running the world. You might have heard of this convention they go to in a town called Davos. I suppose you think they go to hear discussions of what is the best accounting software and how much effort they should put into making a kick ass salad bar in the employee cafeterias.

In general, I would prefer to see wide-scale tax holidays rather than increased debt bondage.

By government ukase, a locked-down economy.

Let the government borrow or print money to finance itself, and let businesses and people keep the money they earn.

Perhaps UBI is warranted for the duration

But really, lockdowns are not a policy. 10 million unemployed in two weeks? And we are in the first inning of this regime?

In World War I, it is said a German general noticed his zeppelins were very vulnerable to enemy fire.

" I have the answer!" he said. "Let's make our zeppelins armor-plated!"

And so the lockdown policy was born.


Dudes: we have a naive population and a novel cold virus. What happens when we end the lockdown?

"Let the government borrow or print money to finance itself ... Perhaps UBI is warranted for the duration"

I see that MMT is picking up steam these days.

Well, when orthodox macroeconomics is in a discredited shambles... and attempts to salvage its reputation by excreting through an interior orifice... then alternative policies begin to have a certain attraction

"Conversion from civilian manufacturing to war production reduced the initial shock to economic activity because war production directly displaced civilian manufacturing."
Military spending has a high multiplier when someone is bombing your civilian supply line. I think we might have a case of digging the hole, then filling.

The difference between WW II and the present situation is that then one hell of a lot of resource switching and utilizing unemployed resources had to be done on a massive scale, whereas in the present resources must be made unemployed to slow the spread of the virus, and a tiny resource switching has to be done to make masks and stuff. This last the American regulatory state has made impossible.

The calls for militarization of resource allocation are misguided, but understandable given the bureaucratic constraints on the use of the market.

I think the difference between this and WWII is that WWII was a massive increase in consumption (if you think of consumption being both goods and services people buy on the home front and material the gov't is buying). The economy had to shift to produce both types of goods AND the gov't enacted policies to decide who would win (consumer rationing, for example, to make sure provisions were available for soldiers).

Here, however, we are going through a massive decrease in consumption. People are staying home, they aren't buying meals or putting wear and tear on their cars going back and forth.

The economy's output has fallen but its consumption has probably fallen more. Purchasing power is building up which implies a rapid return if things return to normal.

No this is entirely wrong.

WW2 was a massive decrease in consumption.

But a massive increase in production.

I defined consumption pretty clearly above to include both consumer and military spending. A guy having eggs and bacon for breakfast is usually counted as consumption and the gov't buying eggs and bacon as government spending G. When looking at WWII where a huge portion of the labor force was serving in uniform it makes less sense to draw the line between the two.

Consumption obviously also increased massively. If production but not consumption increased, then WWII would have had deflation. It didn't, there was price controls, rationing and even then there was still inflation.

One would expect a very low multiplier in a war time economy like the one during WW2. The pay was good, the jobs were there, but production was limited to war time necessities by the WPB, prices were fixed, starting families were deferred and a huge number of young men were effectively removed from the civilian economy.

A multiplier requires that there be goods and services to buy. During the war, everyone had money, but they couldn't buy a car, a new house, a radio set or a nice dress. Even services were limited unless you could pay more than a war time factory. Anyone who expects a high multiplier when flour, meat and sugar were being rationed should be drummed out of the economics profession.

If you want a proper measure of the multiplier, you have to account for all those savings accounts and war bonds that were spent after the war.

Second tier cities are being hit by the virus, entering phase two. None will be as bad as NYC, none are nearly as dense. But in the aggregate, the virus will march at the same phase two rate. The death rate is not dropping. We are still grim.

So you want to spend money on THINGS that will protect you from the virus while millions are suddenly unemployed as part of a ritual sacrifice. Meanwhile professors get paid and the white collar professional class gets to work from home.

The sacrifice is not being shared equally - the little people are really going to be hurt. Unemployment benefits are typically ~50 of salary, and 50% of a small salary is very small. But f*ck 'em right? Who cares?

This is not going to turn out well even if the virus is defeated.

If it isn't ...

Imagine how different this conversation would be if the "work at home" federal, state, and university employees had to sign up for unemployment this week.

Most developed countries go heavy on direct subsidies to people or direct subsidies to companies on the condition that they maintain their payroll. Vote in more Democrats and you'd get the policy you want. Don't and you'll get a massive bailout for the cruise ship industry even though no one is going to want a cruise for another decade.

You must have missed the DEMOCRATS filling the recent emergency bills with pork.

Pork is better for you than some health nuts have lead you to believe.

Borrowing to spend on things we need is fine and so is income support for the unemployed, reducing firms tax bills (but loans from the Treasury, no). So far the biggest failing seems to be -- as in 2008 ad afterward -- the Fed is failing to target NGDP, is allowing aggregate demand fall significantly below aggregate supply as evidenced by the collapse in the beak-even TIPS rate to below 1%. This shows there is a huge AD problem that the Fed is letting go undressed.

The Fed's options for stimulating demand directly are pretty limited. The Fed, for example, can only buy things at market value or make loans backed up by security. There are some cute ideas like letting any American go to the Fed with a sock and get a $10,000 loan, pay it back with 0% interest in a year or don't and the Fed will keep the sock. But ultimately fiscal policy has to come here with the federal government either directly giving money to individuals or spending it directly on things like ventilators, PPE, and research.

Shouldn't this blog post be headed "that was then, this is now". I would point out (as I often do) that we have come to rely too much on rising asset prices for prosperity. Collapsing asset prices, resulting from the coronavirus, will put that policy to the test. Not only can't people consume (due both to the lockdown and to collapsing income), they are feeling poor (due both from collapsing income and collapsing asset prices). I criticized John Cochrane's economic prescription (i.e., let people tap into the billions in home equity) because it ignores collapsing asset prices. To solve the dilemma, some monetarists are suggesting that the Fed buy corporate stocks and bonds in order to re-inflate asset prices. Which reminds me of the expression used by recovering alcoholics: one drink is too many, a thousand is not enough. Can we drink our way out of collapsing asset prices and back to prosperity? I don't think so. If anything good can come out of this catastrophe, it's that reliance on rising asset prices for prosperity is foolhardy. At the outset of collapsing asset prices, Cowen predicted that it would ruin the fiscal dreams of progressives. Maybe. On the other hand, real and broad prosperity is and has always been a function of investment in productive capital. We may not be able to spend our way back to prosperity, but we can invest our way back to prosperity (starting with, according to Cowen, investment in the war against coronavirus).

You say asset prices have collapsed but they are about where they were 5 years ago. If I owned all of, say, Wal-mart or Tesla or Amazon that would still be a pretty good asset.

The Fed has two purposes. The economic one that gets the most discussion is to ensure demand is sufficient to keep the economy humming. Asset purchases are an unorthodox tool for that purpose while the more common tool is controlling the short term interest rate which is more about the production of assets rather than asset prices.

But the other purpose is to ensure capital markets work. By work I don't mean the prices are high or even stable but work in the sense that if you put an order in to sell some stocks or bonds that order can be executed. If the markets are freezing up and orders cannot be executed, then you don't have price information and panic becomes much more likely.

Many assets are fine like this. I can put my house on the market today but I know weeks and many showings can go by before I get an offer and even more to actual closing. The 'true price' of my home is a guess until then. That's not the deal people made with capital markets. Their purpose is to let people park their funds in assets and then move out of those assets as needed. For example, a firm has surplus funds today but has to pay payroll and suppliers in 15 days. I don't think the Fed keeping those markets flowing is the same as trying to generate prosperity via asset prices.

The problems with "spending a great deal of money right now on things that we need" is that;

a. There always something we 'need'. Always something that politicians and bureaucrats have an incentive to try to 'spend a great deal of money on' because that's how *they* get rich - skimming their slice.

b. It never gets paid back and we never build up that surplus which could be tapped in times of emergency.

a. "Need" does not seem that great for things that can currently be brought with money (i.e. food, Internet, gas, electricity). Other things that are needed like masks and ventilators seem unable to be produced in quantity in time despite there being plenty of money to anyone who can.

b. To whom is this supposed to be 'paid back'? Us. To whom is using it? Us again. Your framework here isn't holding together very well.

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