In an op-ed in the Wall Street Journal Robert Barro and Charles Redlick review a subject near and dear to my heart, the empirical evidence for a Keynesian multiplier greater than one:
For annual data that start in 1939 or earlier (and, thereby, include World War II), the defense-spending multiplier that applies at the average unemployment rate of 5.6% is in a range of 0.6-0.7. A multiplier less than one means that, overall, other components of GDP fell when defense spending rose. Empirically, our research shows that most of the fall was in private investment, with personal consumer expenditure changing little.
The theory would have dictated a significantly larger increase. However, advocates for fiscal stimulus as a spur to economic growth can take heart:
Our research also shows that greater weakness in the economy raises the estimated multiplier: It increases by around 0.1 for each two percentage points by which the unemployment rate exceeds its long-run median of 5.6%. Thus the estimated multiplier reaches 1.0 when the unemployment rate gets to about 12%.
In other words as the unemployment rate rises over 12% the multiplier will, indeed, exceed 1.0. The economic policies presently in place may well see to it that happens since they’re creating less economic growth than would otherwise have taken place. That’s what it means when the multiplier is below 1.0.
The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller. However, there is empirical support for the proposition that tax rate reductions will increase real GDP.
However beautiful the theory or splendid for your policy preferences it may be what really matters are the actual empirical results. The actual empirical evidence that deficit spending increases GDP more than it reduces it is slim to nonexistent.
James Joyner takes note of the same op-ed and conjoins it with a graph illustrating what most people think that the government’s interventions have accomplished. Mostly helping bankers and Wall Street investment companies. That may be because the government’s interventions since September of last year have mostly helped the big banks and the remaining Wall Street investment companies. Funny, that.
Another take from Mario Rizzo:
At the outset of the Obama Administration, as Greg Mankiw reminds us, their economists laid out a series of predictions about where the unemployment rate would be with the stimulus package and without it. Currently, the economy is doing worse than their predictions of unemployment without the stimulus and, of course, much worse than the predictions with stimulus.
The stimulus apologists are ignoring the original prediction based on a model. By that prediction the stimulus is doing harm.
But it’s completely consistent with previous experience as the op-ed cited above demonstrates.
John Carney retorts but this is different!:
According to Krugman’s view, our economic growth is stagnating because the global demand for savings has increased too rapidly. The supply of savings–the preference for holding money and its equivalents over investing and spending it–has grown to a level that the economy is under-performing, unable to operate near its existing capacity.
Krugman’s term for this is “a liquidity trap.” Under these circumstances, Krugman argues, even somewhat ineffecient government spending can increase the real GDP because it is actually bringing about new spending and investment rather than just crowding out private sector investment. So you get a benefit–even if there is no multiplier effect.
We’re instinctively skeptical about government spending problems, largely for a host of issues that have little to do with macroeconomics and more to do with political science. Government spending tends to b ewasteful because governmental authorities are captured by special interests and irredeemably ignorant about the unintended consequences of their programs. It almost certainly involves malinvestment in economically unsuitable projects, and can drive further malinvestment by “crowding in” private investment chasing government subsidies.
But Barro and Redlick’s analysis falls short of addressing one of the core arguments for fiscal stimulus, which means the title of their essay–“Fiscal Spending Doesn’t Work”–should at least be amended to read “except maybe in special circumstances such as the ones we face right now.”
This is burden-shifting. It’s not up to Barro and Redlick to provide evidence that the present situation is not different, it’s up to the proponents of fiscal stimulus via deficit spending to demonstrate that it can be effective using evidence of their own, not relying solely on theory. Theory can be wrong. It must be derived from evidence not the other way around.