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Fiscal multipliers

I’ve got to admit my macroeconomics is rusty. I got my PhD in this area but have worked almost entirely in applied microeconomics ever since.

I am worried however about the current debt ceiling outcome in the US mainly because, on the basis of long-held views,  I am an old-fashioned Keynesian It does not make sense to me to put limitations on government spending while US labour markets remain so fragile.  Unemployment in the US remains high at 9.1%  of the workforce and despite a better than expected private sector outcome jobs growth is being limited by a decline in public sector employment.  The debt problems that the US faces are real and have existed for a couple of decades. I do not believe that this is then right time to readdress them although they do need to be addressed down the line.

The key issue justifying this view is my presumption that fiscal multipliers – the number of dollars of GDP created by a $1 increase in government spending – are certainly greater than 1 so fiscal policy yields a more-than-proportionate bang for buck. During slow downs of the type currently being experienced where interest rates are very low that is very likely to be true.   If the economy is growing strongly a fiscal expansion is more likely to raise interest rates and ‘crowd out’ private investment. But that is not the case now.

It is important to check out the veracity of these views – while there aresome libertarian rag-bags who attack activist fiscal policy on ideological grounds, there are also serious macroeconomists in the Barro and Lucas camp who have their reservations.

I was pleased to read confirmation of my own views in a recent piece by Alan Auerbach and Yuriy Gorodnichenko (here). Auberbach is one of the top public economists. They find fiscal multipliers in the range 1.5-2.0 during recessions and cite other studies that provide estimates of between 3-3.5 when labour markets are slack as they currently are.  Translating these into some practical employment outcomes a fiscal expansion of $1b will create around 44,000 jobs at a cost of around $23,000 per job.

This confirms my scepticism about embarking on a program of fiscal restraint at the present time.  It would be nice to get debt down but for the millions of Americans looking for work the human cost of being unable to get work is catastrophic. It should be the first macroeconomic priority.   Its not an either-or choice either. Getting people back into jobs will put the US government into a better position to deal with debt woes. Of course this is all rather academic since this debate has been lost and decade-long fiscal restraints are now in place.  My concern is that this program will drag the current recession out over many years and will not yield either restored economic growth or improved public sector finances. The Auerbach-Gorodnichenko results point the way to go but also suggest that the current fiscal reforms in the US are ill advised.

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