Results for “multiplier”

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Krugman offers a response to a few critics, including I believe myself.  His latter two points are on the macro model, his first point is trying to establish the relevance of the macro model for the minimum wage analysis:

1. Why did I go from minimum wages to overall wages? Clearly, a cut in minimum wages –which only apply to some workers – can raise the employment of those workers at the expense of other workers. But the advocates of a cut are claiming that they can raise overall employment. The only way that can happen is if a reduction in average wages raises employment.

There is a simple story here.  Lower the minimum wage and firms with market power will in general hire more labor.  (Sethi's critique refuses to consider that mechanism but simply shift the MC curve and watch it happen.)  In the most straightforward setting the total wage bill increases, even if the average wage falls.  With a higher total wage bill, there is no downward deflationary spiral.  This general equilibrium point was emphasized by Jacob Viner in his very careful 1937 review of Keynes but it remains a neglected insight.

The negative scenario, namely the total lower wage bill, can possibly occur if employers use the lower legal minimum wage to lower wages for currently employed workers who were at the previous minimum.  A few observations here:

1. Even then the net effect is indeterminate and not necessarily in the Keynesian direction.  The total wage bill still could go up or even if the total wage bill goes down the total flow of purchasing power need not decline, given that employers just don't sit on their extra money.  (This same point applies to all other second-best scenarios.)

2. The model already has assumed short-run wage stickiness, so it would be odd to suddenly relax that assumption as a way to get the total wage bill to fall.  

3. Given that minimum wages don't cover so many workers, the AD effects are likely quite small in any case.

4. The new workers may well be collecting EITC, which will strengthen any aggregate demand effect from their employment.

5. The increase in aggregate supply — more work goes on! — itself has a positive effect on aggregate demand through subsequent Hutt-like, supply-side multipliers.  It would be unusual if velocity shifts were completely neutralizing with respect to this increase in production.

6. The "then why don't we raise the minimum wage to $30 an hour" meme is an overrated "right-wing talking point" in a lot of policy debates.  Still, in this context, it remains a good question from a purely analytical point of view.  Such a change would not boost aggregate demand in most plausible models and from that admission you can work backwards.

Mixing up average wages and the wage bill is a common Keynesian confusion; they're not always moving in the same way, though they may seem to in some very simple models.  Krugman's #1 is assuming a link between the micro and macro change that simply doesn't have to be there.  

That all said, it's a fair enough point to note that changes in the minimum wage will likely bring only small positive effects in any case.

Yes.  Bryan Caplan has the answers:

Paul [Krugman] does address the real balance effect, but he still ignores the main arguments I've made before:

1. Cutting wages increases the quantity of labor demanded.  If labor demand is elastic, total labor income rises as a result of wage cuts. 

2. Even if labor demand is inelastic, moreover, wage cuts reduce labor income by raising employers' income.  So unless employers are unusually likely to put cash under their mattresses, wage cuts still boost aggregate demand.

An even simpler way to explain it: Imagine every firm divided its existing payroll between a larger number of workers.  How is that bad for aggregate demand – or anything but good for employment?

P.S. If you prefer specific facts to textbook arguments, see Scott Sumner's legendary Table 12.2 on wages and the Great Depression.

As Bryan titles his post: "Cutting the Minimum Wage Really is Good for Aggregate Demand."  The actual arguments in Krugman's blog post concern an overall downward spiral in wages and prices, not minimum wage cuts at all.  The chance that minimum wage cuts set off such a spiral is very, very small.  Krugman's third paragraph makes perfect sense but the fourth paragraph and onwards is simply discussing a different topic.

I would add two points.  On Bryan's #1, workers at the current minimum wage are unlikely to receive nominal wage cuts if the minimum wage were lowered, for the usual morale and efficiency wage and lock-in reasons.  So the chance that total labor income rises is very high.  Second, no I don't believe in an upward-sloping AD curve, but in any case multipliers from production increases plus wage bill increases are likely to be more potent than multipliers from aggregate demand increases alone.

Addendum: Will Wilkinson offers relevant comment.

I'm still receiving email pushback on my view that a falling dollar can be good for the U.S. economy.  The critics charge: why not just let the dollar fall close to zero or at least hope for such?  A few points:

1. I'm not asking for a specific weak dollar policy (we've already done enough on that front!).  The point is that if the market brings a falling dollar, this outcome can be part of the equilibrating process.

2. You don't have to approve of all the policies, or private sector practices (e.g., a low savings rate) that produced the weak dollar.  A weak dollar is still a healthy response, given those constraints.

3. Never forget the difference between real and nominal exchange rates.  That answers the conundrum about wishing for a dollar of near-zero value. 

4. A falling dollar will (often, not always) increase employment in the export sector.  Supply-side, production-based multipliers are the best kind to have and they can outweigh the economic costs of higher import prices.  When the dollar falls, a big chunk of that shift is born by foreign exporters like a tax rather than being passed along to U.S. consumers.  The net effect is that Mercedes-Benz subsidizes job creation in the United States.  And sometimes a falling currency is in fact an efficient form of lump sum taxation in this regard.

5. Free traders are usually economic cosmopolitans, which is good.  A weak currency in one country means a strong currency in another and the distribution effect, at least at the first-order level of analysis, is a wash.  So cosmopolitanites shouldn't object to weak currencies per se.  From a global point of view, a lot of currency movements are close to a net wash in efficiency terms, although they may be good for at least one of the countries in the equation.  As a rough rule, weak currencies do the most good where resources are unemployed and there is a realistic elasticity of exports, though it is more complicated than that.

6. A weak dollar poses the biggest problems for the EU and other foreign regions.  Still you can see those as real problems and think a falling dollar is OK for the U.S., taken alone.

7. Again: blah-blah-blah caveats about the difference between a currency falling as a pure thought experiment and a currency falling as associated with some particular cause.  Blah, blah, blah, etc.  Blah.

Daniel Drezner offers related commentary.

The very healthy influence of Scott Sumner has induced me to read the Irving Fisher works I had never looked at before.  Wow.  It’s Fisher, not Keynes, who is the prophet of our times and the superior analyst of the Great Depression.  Circa 1932, Fisher wrote:

…in the depression of 1929-32, while the volume of deposit currency in member banks was falling 21 per cent, the velocity of it was being reduced by 61 percent….a mere new supply of money, to replace what has been liquidated or hoarded, might fail to raise the price level by failing to get into circulation…a mere increase in M might prove insufficient, unless supplemented by some influence exercised directly on the moods of people to accelerate V — that is, to convert the public from hoarding.

One wishes that Keynes were so clear. And what is the best way to restore confidence and break the liquidity trap?  Restoring confidence in banks, so that a multiplier, working through credit, may be effective again.  Fisher also suggests negative interest on reserves and he outlines in detail how this might be done.

That is all from his Booms and Depressions, First Principles, a very sophisticated work.  Pigou, Hawtrey, and Viner are also all worth reading; they are more advanced in their thinking than Keynes was willing to admit.

Hail Irving Fisher, still one of the most underrated economists of the 20th century.  By the way, 1936 – 1932 equals 4.

He is a very smart monetary economist at Bentley.  The blog is here.  Here is a very good post on Keynes's General Theory; excerpt:

When I hear people discuss the long run I am sometimes reminded of
students who mistakenly assume the term ‘long run’ means ‘the distant
future’ and ‘short run’ means ‘the present or near future.’  But that
is not at all what these terms mean.  The present, right now, is the
“long run” for policies instituted years ago.  So if Keynes believed
that in the long run nominal income is determined by monetary factors,
then he should have explained current movements in nominal income in
terms of past movements in monetary policy.  Of course that is not what
the GT does.

And this:

Krugman recognized that Keynes’ liquidity trap rested on a
foundation of sand and attempted to build a model of “expectations
traps” that was consistent with rational expectations.  I have doubts
about this model, but even if one accepts Krugman’s argument it doesn’t
really help the GT very much.  Krugman argued that temporary increases
in the money supply will be hoarded, leaving AD almost unchanged.  But
this would apply even more strongly to budget deficits, which unlike
money supply increases, must be temporary.

If a transitory budget deficit will have no long run impact on
nominal spending (holding money constant) then its effect on current
spending will be even weaker than otherwise.  There is a reason why
modern graduate macro texts place so little emphasis on the ideas that
Keynes developed in the GT, they are very hard to justify in a model
with rational expectations.  What puzzles me is why concepts such as
the MPC, the multiplier, the paradox of thrift, and fiscal stimulus
have recently become so widely debated among economists.  Do these
concepts help us understand movements in nominal spending?  And if so,
what is the model that justifies that view?

It is worth reading every single one of his (twenty-two, so far) posts, even though you must click to get under the fold.

Add Thomas Friedman to Tyler, myself, Lee Ohanian and others suggesting immigration as a way to alleviate the recession:

Leave it to a brainy Indian to come up with the cheapest and surest way to stimulate our economy: immigration.

Note that the multiplier on the “buy a house, get a visa” strategy would be much larger than any possible domestic multiplier since the money would come from outside the economy (and efficiency would improve as well.)
I think there would be considerable support among economists that immigration (buy a house, get a visa), a payroll tax cut and maintaining state and local funding would be reasonably good policies in this recession (albeit not necessarily sufficient) yet these policies seem to be the ones that the political system rejects out of hand.  (See also Matt Yglesias here and here).  Now, I can understand rejecting these policies as compared to doing nothing, ala a precautionary principle, but why these policies are rejected compared to taking a trillion dollar gamble is puzzling even to someone like myself schooled in public choice.

Gary Gorton has written another excellent paper, available here.  It explains one corner of the crisis very well and it is this kind of paper:

Recommended for anyone taking a serious interest in contemporary financial markets and the crisis.  On the question of stimulus, I recommend this discussion for anyone looking to understand why the correct multiplier is difficult to calculate.

Matt Yglesias has a very good post on Robert Barro's latest.  Brad DeLong seems to agree with Matt.  Paul Krugman uses the word "boneheaded" to describe the Barro piece.

This exchange is a good micro-cosm of how the stimulus debate has proceeded.  A highly respected anti-stimulus economist puts up some anti-stimulus evidence in a highly imperfect test (in Barro's defense, he did cover more than just WWII).  The anti-stimulus economist is attacked by pro-stimulus economists.  But the pro-stimulus proponents are focused on attack.  They are not putting up comparable empirical evidence of their own for the efficacy of fiscal policy and there is a reason for that, namely that the evidence isn't really there.

I fully admit that I don't trust the oft-cited evidence that tax cuts are 4x better stimulus than government spending boosts; I think the result is a mirage from underspecified models.  Overall we simply don't know how well the proposed stimulus will work — if at all (is aggregate demand always the relevant war?).  It's a kind of Hail Mary pass, an enduring belief in aggregate demand macroeconomics at the theoretical level, even in light of broken banks, sectoral shifts, and nasty, failing expectations, all mixed in with hard to spend well, slow to come on line, monies.  Yes it could work but our agnosticism should be strong rather than just perfunctory. 

Writing polemics against market-oriented economists, no matter what the failings of such economists (and I am one of them, and I have failings), doesn't get us out of that box.

I'll say it again to the pro-stimulus forces: a stimulus is going to happen, so I'd love to be cheered up by your evidence.  Put it on the table.

I also am confused by Krugman's view of the relevance of WWII.  On his blog, at the end of a discussion of how the historical example of WWII doesn't much apply, he writes:

I can’t quite imagine the mindset that leads someone to forget all
this, and think that you can use World War II to estimate the
multiplier that might prevail in an underemployed, rationing-free
economy.

And he is upset at Barro for thinking that the WWII experience does apply.  Fair enough, but a) the War didn't start at full employment, and b) is it possible that Barro received this impression from reading Krugman himself?  In Rolling Stone last week Krugman wrote:

It
took the giant public works project known as World War II – a
project that finally silenced the penny pinchers – to bring
the Depression to an end.

The lesson from FDR's limited success on the employment front,
then, is that you have to be really bold in your job-creation
plans. Basically, businesses and consumers are cutting way back on
spending, leaving the economy with a huge shortfall in demand,
which will lead to a huge fall in employment – unless you
stop it. To stop it, however, you have to spend enough to fill the
hole left by the private sector's retrenchment.

If you read both Krugman passages closely, there is not actually a literal contradiction.  But still, a fundamental decision has to be made on whether to run away from the WWII evidence or not.  I say the WWII evidence does not apply and so I am closer to Krugman as he writes on his blog.

Either way you cut it, there aren't any boneheads in the room.

He makes many good points.  Excerpt:

The
evidence is fuzzy, to be sure, but to me it suggests a multiplier
around one, maybe smaller. Even stimulus cheerleader Paul Krugman only
claims 1.1. If that’s the case, the impact of government spending (say
700b over two years) is barely enough to reverse the decline in GDP we
expect to see over the next two quarters.

Read the whole thing.

I believe that most current advocates of a huge fiscal stimulus have two major arguments in mind.  The first is that "when resources are unemployed, in principle government spending can put them back to work, times are dire so we need this."  The second is the Galbraithian point that public sector expenditure has been starved for a long time so in principle there are plenty of good ways to spend money through government.  In the predominant mental model on this topic, it is believed either of these arguments suffices to justify a large fiscal stimulus.  In the debates I sometimes find that when one claim is criticized there is a mental switch back to the other.

Don’t let those switches distract you.  My point is simple: it is very hard to find examples of successful fiscal stimulus driving an economic recovery.  Ever.  This should be a sobering fact.  The New Deal doesn’t count because fiscal policy wasn’t very expansionary then.  American participation in World War II doesn’t count.  Nazi Germany during the 1930s doesn’t count.  (Read Matt Yglesias’s response; the point however is that maybe Hitler couldn’t have easily spent the money on something else in a rapid and effective fashion; if he could have they why can’t we find more examples of a fiscal-policy lead recovery elsewhere?).  I’ll cover Japan in the 1990s and other examples soon.

Don’t be mesmerized by a static, aggregated AD-AS diagram into thinking surely it must be easy.  Whether the government can target unemployed resources effectively, and deliver the right stimulus in time, is a major question and so far the evidence isn’t so convincing.  Keep in mind there are good reasons why truly major fiscal stimulus hasn’t been tried very often.

Here’s Free Exchange on the research behind fiscal policy.  They write:

Today, Mr Cowen links
to a(nother) piece of macro research on stimulus multipliers that finds
in favour of tax cuts before declaring that "the science isn’t there",
to support deficit spending as stimulus.

The point is not that I think tax cuts are much better than government spending as stimulus; I don’t.  The NBER piece I cited considers the possibility that tax cuts bring a multiplier of as large as five.  I say no way.  The point is not to argue for tax cuts.  The point is to note that this is the best research that the highly reputable NBER can come up with on the topic.  What does that say about prevailing standards of evidence and proof in the area as a whole?  It means they are very weak and that we know very little.  This is not "the evil and corrupt WSJ Op-Ed page," this is the NBER and the researchers have done as good a job as others on this topic or maybe better.  And what they have produced still isn’t very believable.

The bottom line is this: we are being asked to believe that a big, trillion or even multi-trillion fiscal stimulus can boost the current macroeconomy.  If you look at history, there isn’t good reason to believe that.  Any single example, such as the Nazis, can be knocked down for lack of relevance or lack of correspondence to current conditions.  Fair enough.  But the burden of proof isn’t on the skeptics.  It’s up to the advocates of the trillion dollar expenditure to come up with the convincing examples of a fiscal-led recovery.  Right now we’re mostly at "It wasn’t really tried."  And then a mental retreat back into the notion that surely good public sector project opportunities are out there.

So what you have is the possibility of faith — or lack thereof — that our government will spend this money well.

And that is under "emergency" conditions, with great haste ("use it or lose it"), with a Congress eager to flex its muscle, and with more or less one-party rule.

For me, that’s not enough.

Hot off the presses from the NBER, from Andrew Mountford and Harald Uhlig, the evidence is mounting:

We propose and apply a new approach for analyzing the effects of fiscal
policy using vector autoregressions. Specifically, we use sign
restrictions to identify a government revenue shock as well as a
government spending shock, while controlling for a generic business
cycle shock and a monetary policy shock. We explicitly allow for the
possibility of announcement effects, i.e., that a current fiscal policy
shock changes fiscal policy variables in the future, but not at
present. We construct the impulse responses to three linear
combinations of these fiscal shocks, corresponding to the three
scenarios of deficit-spending, deficit-financed tax cuts and a balanced
budget spending expansion. We apply the method to US quarterly data
from 1955-2000. We find that deficit-financed tax cuts work best among
these three scenarios to improve GDP, with a maximal present value
multiplier of five dollars of total additional GDP per each dollar of
the total cut in government revenue five years after the shock.

The emphasis is mine.  I’m not saying you have to believe this paper in all its details (I don’t), but over the next year you will continue to hear talk about the wonders of government spending as fiscal policy.  The science isn’t there.  Here are ungated versions of the paper.