Results for “multiplier”

112 found

These points have been far too often forgotten:

Even if the multiplier is substantially above 1, it is not obvious that stimulus spending is a good idea. The reason is that we are not trying to maximize output and employment – we are trying to maximize overall social well-being. At a basic level, the idea behind stimulus spending is that the government will spend money on stuff that it wouldn’t have purchased if we weren’t in a recession. The classic caricature of stimulus spending is the idea of paying a worker to dig a hole and then paying another worker to fill the hole in. This type of stimulus spending will increase employment and GDP but it won’t really enhance social welfare. True, we might get the beneficial effects of the stimulus but we could achieve that by simply giving the workers the money without requiring that they dig the holes. If we simply give out the money, GDP increases by less but social well-being goes up by more since the work effort and time wasn’t required.

Even though the Keynesian hole-digging example is silly, the same argument can be applied to any type of government spending. If a project doesn’t meet the basic cost / benefit test, then it shouldn’t be funded, regardless of the need for stimulus.  Of course, one form of fiscal stimulus used in the ARRA was providing funds to state governments so they could maintain services that they would normally provide. This is perfectly sound policy because it is allowing the government to continue to fund projects that (presumably) do pass the cost / benefit calculation. If the social value of a government project exceeds its social cost then we should continue to fund the project whether we are in a recession or not. If the social value falls short of the social cost then, even if the economy is in “dire need” of stimulus we should not fund it. If we really need stimulus but there are no socially viable projects in the queue then the government should use tax cuts. Tax cuts can be adopted quickly and aggressively and, unlike spending initiatives, apply to virtually all Americans.

There are other “legitimate” reasons for the government to expand spending during a recession. The most obvious is that many things are relatively cheap in recessions. Reductions in manufacturing and construction employment may lower the cost for government projects. But again, this decision can be made on a simple cost / benefit basis. If prices fall because of a recession and this makes some projects socially viable as a result, then it’s perfectly correct for the government to fund those projects.

If it makes people feel better we could re-label tax cuts as spending. I could pay people $200 to look around for better paying jobs. This would be counted as $200 of job searching services purchased by the government but in reality, the money would be essentially the same as a tax cut.

The full post is here.

There has been a recent kerfluffle over whether Robert Barro rejects the notion of aggregate demand, which he had written with quotation marks as “aggregate demand.”  Scott Sumner surveys the back and forth.

I say use The Google to find out what Barro really thinks and indeed he has written a whole piece on the topic (jstor), namely “The Aggregate-Supply/Aggregate Demand Model,” from the mid 1990s, and here is the abstract:

In recent years, many macroeconomic textbooks at the principles and intermediate levels have adopted the aggregate-supply/aggregate-demand (AS-AD) frame- work [Baumol and Blinder, 1988, Ch. 11; Gordon, 1987, Ch. 6; Lipsey, Steiner, and Purvis, 1984, Ch. 30; Mankiw, 1992, Ch. 11]. The objective was to allow for supply shocks in a Keynesian framework and to generate more satisfactory predictions about the behavior of the price level. The main point of this paper is that the AS-AD model is unsatisfactory and should be abandoned as a teaching tool.

In one version of the aggregate-supply curve, the components of the AS-AD model as usually used are contradictory. An interpretation of the model to eliminate the logical inconsistencies makes it a special case of rational-expectations macro models. In this mode, the model has no Keynesian characteristics and delivers the policy prescriptions that are familiar from the rational-expectations literature.

An alternative version of the aggregate-supply curve leads to what used to be called the complete Keynesian model: the goods market clears but the labor market has chronic excess supply. This model was rejected long ago for good reasons and should not be resurrected now.

If you read the paper, you will see three things.  First, Barro is fully aware of “AD-like” phenomena and does not reject that notion.  Second, Barro seems to prefer the IS-LM model to AS-AD, albeit with some caveats about possible false predictions of IS-LM and also noting in footnote two that he prefers his own presentation in his 1993 text.  Third, Barro’s criticism is (whether you agree or not) that AD-AS collapses too readily into standard rational expectations models and doesn’t really provide an independent foundation for sticky price macroeconomics.  In a nutshell “The AS-AD model is logically flawed as usually presented because its assumption that the price level clears the goods market is inconsistent with the Keynesian underpinnings for the aggregate-demand curve.”

Krugman had written this:

If you read Barro’s piece, what you see is a blithe dismissal of the whole notion that economies can ever suffer from am inadequate level of “aggregate demand” — the scare quotes are his, not mine, meant to suggest that this is a silly, bizarre notion, in conflict with “regular economics.”

I believe that is not a good characterization of Barro’s views and it is also an object lesson in the importance of the Ideological Turing Test.  I would cite not only this piece, but also forty years of journal articles, many of which study the importance of nominal shocks and demand, albeit without (in general) using textbook AD-AS terminology.  Indeed, Barro working with Herschel Grossman is one of the founding fathers of quantity-constrained Keynesian sticky-price macro and he is still citing this work favorably in his mid-1990s piece; see for instance Barro and Grossman (1971, 1974) and also their book from 1976: “This is a textbook on macroeconomic theory that attempts to rework the theory of macroeconomic relations through a re-examination of their microeconomic foundations. In the tradition of Keynes’s General Theory of Employment, Interest and Money…”

On the UI issue, I would note that the multiplier from transfers is likely unimpressive relative to the multiplier from government consumption.

That is the title of a new and very good John Cochrane blog post on fiscal stimulus.  Here is one excerpt from Cochrane:

New-Keynesian models act entirely through the real interest rate.  Higher government spending means more inflation. More inflation reduces real interest rates when the nominal rate is stuck at zero, or when the Fed chooses not to respond with higher nominal rates. A higher real interest rate depresses consumption and output today relative to the future, when they are expected to return to trend. Making the economy deliberately more inefficient also raises inflation, lowers the real rate and stimulates output today. (Bill and Rong’s introduction gives a better explanation, recommended.)

So, the key proposition of new-Keynesian multipliers is that they work by increasing expected inflation. Bill and Rong look at that mechanism: did the ARRA stimulus in 2009 increase inflation or expected inflation?  Their answer: No.

The paper itself is here.

Stephen Williamson writes:

What about wage stickiness? That’s certainly important in the Keynesian narrative, though New Keynesians tend to think more about sticky prices. Suppose, for the sake of argument that a particular worker’s wage had been stuck at its pre-financial crisis nominal level until now. How much would that worker’s wage have declined in real terms by mid-2013? The answer depends on when the worker’s wage became stuck. If it was in January 2007, the decline would be 12% (using pce inflation); if in December 2007, 9%; and if when Lehman went down, 6%. That’s large in any case, and that’s with zero adjustment over 5 or 6 years. You think wage stickiness matters over that length of time, or that wage stickiness somehow explains the drop in employment we saw in the construction sector? I don’t think so.

Don’t forget that nominal gdp is now well above its pre-crash peak (some sticky wage theorists are morphing into “the stickiness is that almost everyone has to get a two percent raise each year,” a very different proposition than downward stickiness at the zero point and one with much less evidence behind it).

There are several other interesting observations in the piece.  I don’t completely agree with this set of points (for one thing I don’t view TFP and investment as so readily separable), but they are nonetheless worth a ponder:

Probably the most important feature of the data in the two charts is the difference in the behavior of investment. In 1981-82, investment declines by about 12% from the first observation, then rebounds significantly, to the extent that it grew more than consumption and output by mid-1983. In the last recession, investment declined by more than 30% from the beginning of 2007 to mid-2009, and in second quarter 2013 was still about 5% lower than in first quarter 2007. Thus, if there is something we should be focusing on, it’s not multipliers and consumption, but why investment is so low. That low level of investment, over a five year period, has now had a significant cumulative effect on the capital stock. Thus, we’ve got OK growth in TFP, but growth in factor inputs is low. That’s the key story, from a growth accounting point of view.

You should not, by the way, think I have changed my mind on monetary policy.  The “nominalist” approach was absolutely correct for 2008-2009, it is simply becoming less correct as time passes, which is exactly what standard economic theory suggests.

Don’t worry too much about the failings of the Austrian economists themselves, rather focus on what we can learn from them.  That is the tack taken by Guillermo Calvo in a recent paper (pdf), here is one excerpt:

I will argue that the Austrian School offered valuable insights – disregarded by mainstream macro theory…Over‐extension of credit was at center stage of the Austrian School theory of the trade (or business) cycle, but authors differed as to the factors responsible for excessive credit expansion.  Mises (1952), for instance, attributed excessive expansion to central banks’ propensity to keeping interest rates low in order to ensure full employment at all times.  As inflation flared up, interest rates were raised causing recession. Thus, under his view the cycle is triggered by pro-cyclical monetary policy with a full-employment bias which was not consistent with inflation stability. Hayek (2008), on the other hand, dismissed von Mises explanation, not because it was not a good depiction of historical events, but because he thought that instability is something inherent to the capital market and, in particular, it is related to what might be called the banking money multiplier mirage. His discussion conjures up contemporary issues, like securitized banking, for example. At the risk of oversimplifying, Hayek’s views, a phenomenon that seems central to his trade cycle theory is that credit expansion by bank A induces deposit expansion in bank B who, in turn, has incentives to further expand credit flows, etc. If bank A makes a mistake, the money-multiplier mechanism amplifies it.  This is reminiscent of misperception phenomena stressed in Lucas (1972). Hayek’s discussion does not exhibit the same degree of mathematical sophistication but focuses on a richer set of highly relevant issues.  For example, that credit expansion is not likely to be evenly spread across the economy, partly because of imperfect information or principal-agent problems.  This implies that credit expansion is likely to have effects on relative prices which are not justified by fundamentals. Shocks that impinge on relative prices are hardly discussed in mainstream close-economy macro models. Hayek’s theory is very subtle and shows that even a central bank that follows a stable monetary policy may not be able to prevent business cycles and, occasionally, major boom-bust episodes.  Unfortunately, Hayek does not quantity the impact of perception errors…

That is a bit long-winded, so here is how I would express some related points:

1. Once you cut through the free market (or anti-market rhetoric), the Austrian theory is not as different from Minsky’s as it sounds at first.  And both sides hate it when you say this.

2. There may be a fundamental impossibility in maintaining orderly credit relations over time and the more sophisticated versions of the Austrian theory get at this.  Keynes thought that too, but arguably “the liquidity premium of money itself” is a red herring when trying to understand this issue.  In that sense Keynes may have been a step backwards.

3. The Austrian theory may require a rather “brute” behavioral imperfection concerning naive short-run overreactions to market prices, quantities, and flows.  For reform economies, newly developing economies, and economies coming off a “great moderation,” this postulate may not be entirely unreasonable.

4. That credit booms precede many important busts, and play a causal role in those busts, and shape the nature of those busts, is a deeper point than Keynes let on in the General Theory.

5. One should never use the Austrian theory to dismiss the relevance of other, complementary approaches, most of all those which stress the dangers of deflationary pressures.

6. I don’t exactly agree with Calvo’s Mises vs. Hayek framing as stated.

The paper is interesting throughout and also offers a good discussion of Mexico’s peso crisis, and the point that, while allowing a deflationary contraction is a big mistake, simply trying to reflate won’t set matters right very quickly because there are real, non-monetary problems already baked into the contraction.

The original pointer is from Peter Boettke, who discusses the piece as well.