In the Wall Street Journal this morning economist Robert Barro questions the effectiveness of fiscal stimulus:
I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports — personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses — there was a dampener, rather than a multiplier.
We can consider similarly three other U.S. wartime experiences — World War I, the Korean War, and the Vietnam War — although the magnitudes of the added defense expenditures were much smaller in comparison to GDP. Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 — the same value as before. (These estimates were published last year in my book, “Macroeconomics, a Modern Approach.”)
There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.
To decipher the econ-speak if a stimulus plan has a multiplier of 1. that means that it has no effect on GDP since every dollar in increased government spending is balanced by a dollar of decreased private spending with no net effect on GDP. If a plan has a multiplier greater than 1, it means that for every dollar of increased government there’s more than a dollar’s worth of effect on the GDP. So, for example, if the multiplier is 1.5, for each dollar’s worth of spending, GDP increased by fifty cents. If the multiplier is less than one, then the measure would actually reduce GDP. Or at least that’s the way I understand it.
Apparently, the Obama Administration has been working under the assumption that the Keynesian multiplier is 1.5.
As regular as clockwork Paul Krugman responds:
Actually, I’ve already taken that one on. But just to say it again: there was a war on. Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort.
Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone?
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.
What gripes me about this discussion is that everybody wants to argue the negative, picking holes in the opponent’s argument; nobody wants to make an affirmative case.
In order to have a really constructive discussion advocates for a fiscal stimulus package need to make an affirmative case, showing and supporting their claims. That’s the rule: the burden of proof is on the affirmative. That, of course, is why everybody wants to argue the negative. It’s so much easier.
I don’t doubt that an affirmative case can be made; I just haven’t seen one. Recently, whenever I’ve seen an argument for a multiplier of this or a multiplier of that, I’ve followed all the references and so far I’ve seen little but unsupported claims or ceteris paribus statements.
It’s time for reputations to go on the line. Make the argument. Support the claims.
Matthew Yglesias makes a point that Megan McArdle has made from time to time, namely, that there may be diminishing returns to scale in a fiscal stimulus plan:
World War II spending was enormous relative to GDP. Wartime spending on that kind of scale goes way beyond the conversations we’re having right now about fiscal stimulus—the equivalent today would be something like a $5.2 trillion package rather than the $800 billion or so we’re talking about. And to get spending up to that level the government had to resort to quasi-forced savings (”war bonds”), rationing, etc.—deliberate efforts to direct production away from where demand was highest and toward the national objective of military production. The 0.8 multiplier is probably the result of diminishing returns. The question is whether you got a decent multiplier out of the first 5-10 percent of GDP you spend on stimulus.
A change from a multiplier greater than one to one less than one isn’t just diminishing returns to scale. It’s negative returns to scale—becoming counterproductive.
Are there diminishing returns to scale? At what point does that occur? $5.2 trillion? $800 billion? $100 billion? These aren’t questions that can be settled on the basis of pure reason. I want to see the data.