More on Multipliers (and a Surprising Perverse Effect)

This morning I decided to track down this citation from a WSJ article:

So, as I and others warned in 2008, the permanent government expansion and higher tax rate agenda is a classic example of what not to do during bad economic times. Worse yet, all the subsidies, bailouts, regulations and mandates are forcing noncommercial decisions on the economy, which now awaits literally thousands of new diktats as a result of things like ObamaCare and the financial reform bill. The uncertainty is impeding investment and hiring.

The president does not say that economists agree that the high future taxes to finance the stimulus will hurt the economy. (The University of Chicago’s Harald Uhlig estimates $3.40 of lost output for every dollar of government spending.) Either the president is not being told of serious alternative viewpoints, or serious viewpoints are defined as only those that support his position. In either case, he is being ill-served by his staff.

The emphasis is mine.

The paper in question appears to be this one (PDF) and I commend it to the attention of the mathematically inclined. It contains a number of findings that some may find surprising or even perplexing. For example, Dr. Uhlig’s findings are that a deficit funded tax cut over four quarters produces outputs of .53 (for every dollar of cut 53 cents are added to GDP) and deficit funded government spending over four quarters produces outputs of .31 (more than three dollars of spending are required to produce each additional dollar of GDP).

For me that wasn’t the most surprising result. This was:

…the basic government spending shock stimulates output during the first four quarters although only weakly and has only a very weak effect on private consumption. It also reduces both residential and non-residential investment, although interestingly not via higher interest rates. Although no restriction is placed on the behavior of government revenue this does not change very significantly and so the basic government spending shock will resemble a fiscal policy shock of deficit spending, whose responses are displayed in Figure 7 in section 4 below. The response of prices to the increase in government spending is a little puzzling since both the GDP deflator and the producer price index for crude materials show a decline.

The reason it surprised me is that to my untutored eye it tracks what we’re actually seeing very closely, i.e. very weak stimulatory effect, crowding out albeit not by raising interest rates, and prices declines. Am I mistaken or do the price declines attendant to deficit funded spending as fiscal stimulus suggest that it is a perverse strategy in the case of deflation since it will actually produce the consequences you may be trying to avoid?

I found lots of other interesting findings in some of Dr. Uhlig’s other papers including a quantitative measurement of where the United States and the EU are on the Laffer Curve. Unsurprisingly, tax cuts in Europe would be significantly more self-financing than in the United States. In neither case would either reducing taxes on income or taxes on capital be self-financing but in Europe reducing taxes on capital would very nearly be so.