Can Someone Give Me the Numbers? (Update)

Today both Paul Krugman and David Brooks have reacted to the news that consumer spending has contracted by suggesting increased government spending to make up the difference.

Consumer spending has decreased:

WASHINGTON – Beaten down and watching their wealth shrink, Americans are cutting back sharply on their spending, trimming it in September by the largest amount in four years.

The Commerce Department reported Friday that consumer spending dropped by 0.3 percent in September, the biggest setback since June 2004. It followed two months in which spending was flat and left activity for the quarterly falling by the biggest amount in 28 years.

The weakness in consumer spending, which accounts for two-thirds of total economic activity, dragged the overall economy down in the third quarter. The gross domestic product, the broadest measure of economic health, also fell by 0.3 percent in the third quarter, the strongest signal yet that the country has fallen into a recession.

Many economists believe that economic activity will fall even more sharply in the current quarter, meeting the classic definition of a recession as at least two consecutive quarters of declining GDP.

I’ve been saying for eight years now that we’ve been overemphasizing consumer spending, we needed to diversify the economy more, and that there would be a price to pay. We’ve come to that point.

Here’s Dr. Krugman’s advice:

The ongoing efforts to bail out the financial system, even if they work, won’t do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we’ve seen, Americans were overextended even before banks started cutting them off.

No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.

and David Brooks’s:

The smart thing to do is announce a short-term infrastructure initiative to accelerate all those repair projects that can be done within a few years. Then, begin a long-term National Mobility Project.

Create a base-closings-like commission to organize federal priorities (Congress has forfeited its right to micromanage). Streamline the regulations that can now delay project approval by five years. Explore all the new ideas that are burgeoning in the transportation world — congestion pricing, smart highways, rescue plans for shrinking Midwestern cities, new rail and airplane technologies. When you look into this sector, you see we are on the cusp of another transportation revolution.

The problem with all this as I see it is that the money must come from somewhere. Either you’ve got to tax more or borrow more or, if you’re not worried about inflation, the Fed can just create it. Any of those are bound to have secondary effects which need to be considered in any plan.

I can’t help but feel that both of these ideas are rooted in a nostalgic idea of what things were like in the 1930’s. It’s been nearly 40 years since I took economics but I seem to recall something called the “Keynesian multiplier”. That’s the idea that you can get a substantial effect from a modest amount of government spending due to the jobs created, increased consumption, and so on.

But there’s also the opposite of that: the deadweight loss of government spending. Government spending allocates resources less efficiently than the market would have done. As I recall that’s estimated at about 25%.

Things in the 1930’s were very different than they are now. In the 1930’s government at all levels accounted for less than 10% of the economy. That increased during World War II and in the period after the war government has come to account for 25% or more of the economy and has never really looked back.

So, Mr. Economist, here are my questions:

  1. How much are you planning to spend?
  2. Will the Keynesian multiplier exceed the deadweight loss of government?
  3. What will the secondary effects of your plan be?

And, while I realize that this idea can’t possibly get much political traction under the present circumstances, couldn’t the same effect be achieved (with the same adverse fiscal consequences) by cutting business taxes? If done with some prudent requirements that could have the beneficial secondary effect of diversifying our economy away from consumer spending which I don’t believe the other plans would do.

Please, give me the numbers.

Update

I’ve found some of my own numbers in this excellent summary post at Econbrowser. Based on the numbers in the post the greatest bang for the buck would be realized by extending unemployment benefits and temporarily increasing food stamps (which I’ve already come out in favor of). The problem that I see with big government spending programs suggested by Dr. Krugman and David Brooks is that they have a tendency to outlive the crisis they’re intended to deal with and take on a life of their own.

I’ll put in another plea for my favorite large scale engineering program: a new national energy transmission backbone. Much better secondary effects than Brooks’s transportation infrastructure idea, which has adverse secondary effects including increased sprawl, greater built-in gasoline consumption, more carbon production, and other adverse environmental effects.

2 comments… add one
  • Personal Consumption Expenditures (PCE) make up slightly over 70% of GDP. To make up for 3.1% decline in PCE you’d need to increase government expenditures by $313.1 billion dollars or so. That would be more than a 10% increase in government spending.

    I can’t help but feel that both of these ideas are rooted in a nostalgic idea of what things were like in the 1930’s. It’s been nearly 40 years since I took economic but I seem to recall something called the “Keynesian multiplier”. That’s the idea that you can get a substantial effect from a modest amount of government spending due to the jobs created, increased consumption, and so on.

    The Keynesian multiplier is a bit of myth in that, as you note, the money must come from somewhere. Suppose we obtain the money via taxes, that the coefficient on consumption spending is 90% (i.e. people spend 90% of their money) and that we are talking $100, just to keep the number simple. Now the mulitplier suggests that we should see something on the order of $900 in new consumption, thus GDP goes up by $900. But hold on! We took that money from people in group A and gave it to group B. If we’d just left it with group A, they’d have given use entirely the same result unless you belive A will bury the money in their back yard or hide it in the mattress. Further, to get that $100 we’ll have to lose something like $105 from the economy due to deadweight loss.

    Typical multiplier stories work with the government having some money that it just happens to find and is tossed out of a helicopter. No really. As you can see it is not likely to be producing the results that the theory claim.

    Now…if the government was taxing people such that they built up a surplus in boom times, then in bust times tapped that money…well then we might see that multiplier during that bust. But our politicians don’t do that. They typicall spend all the tax money and more, so the idea of using the multiplier is not going to work. If we create the money via inflation that is simply another type of tax. And if the money is borrowed, then it is simply being diverted from another productive enterprise, so again no multiplier.

    The secondary effect will be to increase the size of the deficit by…what well over 60%? But hey, GDP went down 0.3% on an annual basis last quarter….my God the sky IS falling!!!!1!!11one!!!

  • Larry Link

    Who has the numbers? You can’t know that until the crises is over, and the crises is just getting started…

    http://www.smirkingchimp.com/thread/18309

    “While many eyes are focusing on the housing meltdown and its hugely negative effect on an economy clearly moving into recession, few are paying attention to the next bubble expected to burst: credit cards.

    How bad is it?

    * Financial analysts say that in the U.S. alone more than $850 billion in unpaid credit card balances is at stake and fast approaching $1 trillion, roughly the same amount as in the subprime market.

    * CNN reports that worldwide, consumers have racked up more than $2.2 trillion in purchases and cash advances on major credit cards in just the last year.”

    Oh yes, we still have an energy issue…winter is coming on..my goodness, we appear to be in over our heads this time…

Leave a Comment