Martinned: @ShelbyC: I don’t think we disagree (except that you seem to prefer dogma over empirical study), but I’m also not entirely sure that you understand what these authors did and what their results mean.

Well, I haven’t been trying to disagree with you, per se. And maybe I don’t understand, my understanding is that they are claiming that govt spending decreases aggragate demand. And one of the things I’m trying to say is that I’m not sure how useful including govt spending is.

ShelbyC: At least private spending involves someone saying, I’d rather have X artifact than Y currency.

And government spending involves taking money from someone who would consume x% of it, and putting it in the pocket of someone who would consume y% of it, leading to an increase (decrease) in consumption of about (y-x)%-points, as well as to a change in savings, in investment, etc. etc.

It creates income, though. Whether it creates wealth depends on what you mean by wealth. If you mean capital, then the answer is that only part of government spending results (indirectly) in an increase in the capital stock, maybe.

I mean artifacts or services that folks wish to consume. That could mean capital, to the extent (as you suggest) that capital increases the production of such artifacts.

All government spending goes into someone’s pocket, and from there it will either be consumed or saved, etc. etc.

And it comes out of someone’s pocket. Whether the spending produces wealth determines whether we’re paying the person to produce, say, food for babies, or whether we’re paying them to dig holes and fill them in. At least private spending involves someone saying, I’d rather have X artifact than Y currency.

However, I’d like to suggest that to focus on the spending multiplier as your “measure of effectiveness” is overly reductive, and suggests (via the math models) that investments must pay returns in the first, and, possibly, second years. The $50,000 paid to a 1st grade teacher may well have a multiplier less than one, but that doesn’t mean that we shouldn’t have schools. Stimulus programs naturally tend to go to projects within the ordinary realm of government, which often pay returns over very long periods, and which may pay returns in non-monetary forms.

I’d also like to suggest that it may make sense for government to invest heavily during recessionary times simply because they can get better prices for roads, buildings, etc. At least one private institution that I belong to is rushing to get bids out on a building project while the economy is slack.

This is, of course, what seperates stimulus from spending. It’s one thing to suggest that the govt should spend more money because we want more services, it’s another to suggest that the govt should spend money to stimulate the economy. And paper is measuring the effectiveness of the latter, not the former.

SeaDrive: The $50,000 paid to a 1st grade teacher may well have a multiplier less than one, but that doesn’t mean that we shouldn’t have schools.

That’s very true. A truly sophisticated model would account for that as an investment in human capital, but I highly doubt that these authors did that.

ShelbyC: I can change the hypo so that they are exchanging the rubber ball for the $100. Point is, as AZ points out, not all spending creates wealth. I’ve got half a mind to yank G out of the model alltogether.

It creates income, though. Whether it creates wealth depends on what you mean by wealth. If you mean capital, then the answer is that only part of government spending results (indirectly) in an increase in the capital stock, maybe. But that is beside the point. By assumption, the only thing that ultimately generates utility for the people is consumption. Capital goods are only interesting to the extent that they produce more for less, etc. Similarly, the choice of how much of one’s disposable income to consume (dC/d(Y-T)) is about consumption now or consumption in the future.

All government spending goes into someone’s pocket, and from there it will either be consumed or saved, etc. etc. The question is whether the increase in spending does more harm than good. That’s an empirical question, depending in part on how the spending increase is paid for.

The available empirical evidence does not support the idea that spending multipliers typically exceed one…

I’m not qualified to evaluate the paper or its conclusions, except that as a mathematician who has worked with economic time series, I’m skeptical of any study patching together data over more than a few years.

However, I’d like to suggest that to focus on the spending multiplier as your “measure of effectiveness” is overly reductive, and suggests (via the math models) that investments must pay returns in the first, and, possibly, second years. The $50,000 paid to a 1st grade teacher may well have a multiplier less than one, but that doesn’t mean that we shouldn’t have schools. Stimulus programs naturally tend to go to projects within the ordinary realm of government, which often pay returns over very long periods, and which may pay returns in non-monetary forms.

I’d also like to suggest that it may make sense for government to invest heavily during recessionary times simply because they can get better prices for roads, buildings, etc. At least one private institution that I belong to is rushing to get bids out on a building project while the economy is slack.

On a completely different note, I think that recession is probably the only phenomenon that can cause state and large city governments to trim their bureaucracies, but I fear they cut the indians more than the chiefs.

Actually, that one has a multiplier of exactly one: it neither hurts nor harms the economy.

I can change the hypo so that they are exchanging the rubber ball for the $100. Point is, as AZ points out, not all spending creates wealth. I’ve got half a mind to yank G out of the model alltogether.

Cheers,

A. Zarkov: My basic disagreement is with current policy has to do with debt. Excessive debt has caused the problem, and I don’t see how more debt it going to fix it, except for the very short run.

The problem was debt taken on by individuals and institutions with liquidity constraints. If you take on short-term debt (e.g. selling commercial paper or taking on a typical subprime mortgage where you are forced to refinance after two or three years) and use the proceeds for investment that may only generate cash flows or capital appreciation over a long period of time you carry liquidity risk. The liquidity crunch hit everyone in this situation very hard because they were forced to sell off assets in a depressed market to satisfy their creditors.

Government does not have this problem at the moment. Short-term interest rates are near zero and after Lehman failed and everyone else was scrambling to raise short-term capital, T-bills actually carried negative yields. People would actually pay $101 for a security that will only pay them $100 in the future.

There is a falsifiable hypothesis here. If in two or three years, inflation and yields on government debt reach the 10%-20% range and if the government faces one or more failed auctions for its bonds, you are right. If this doesn’t happen, you are wrong. The points is that right now we are nowhere near this situation and the least bad option seems to be deficit spending while also planning to let the Bush tax cuts expire once growth and unemployment return to normal.

Martinned:
I’ve just started reading Minsky’s Stabilizing an Unstable Economy, so can I get back to you? (That book is not about housing bubbles, per se, but I’m told it is extremely pertinent to the current recession.)

You might want to look at Steve Keen’s PhD thesis here. The first two chapters provide an introduction to the subject.

How many economists say the housing bubble collapse? How many predicted the downturn in the economy?

I’ve just started reading Minsky‘s Stabilizing an Unstable Economy, so can I get back to you? (That book is not about housing bubbles, per se, but I’m told it is extremely pertinent to the current recession.)

Arkady: Megan says something interesting:

That’s a good moral principle: Always be suspicious when seemingly flawless reasoning leads you to a result that you already really liked when you started.

How many economists say the housing bubble collapse? How many predicted the downturn in the economy?

All the Austrians.

I’ve discussed the underlying paper with Barro, and it seems pretty compelling; they’ve got a hell of a time series. On the other hand, I know that this work fits both his and my political convictions, so there’s a good chance we’re both missing something.

Excessive debt has caused the problem, and I don’t see how more debt it going to fix it, except for the very short run.

Unfortunately this is part of the problem. It’s advantageous to have a lower national debt when we’re born than when we die.

Martinned:
There are a number of questions and remarks here.

I think we are in full agreement here. Your argument is correct within the basic framework of Keynesian economics. As for non-equilibrum modeling, see the work of Steve Keen. His blog is here.My basic disagreement is with current policy has to do with debt. Excessive debt has caused the problem, and I don’t see how more debt it going to fix it, except for the very short run. To know what the short run and the long run are, we need dynamic modeling and that’s what keen is giving us. Moreover as Keen points out, current macro modeling does not explain the observed behavior of M0 (base money) and M1 and M2. It looks like M1 and M2 are driving M0.

Finally for the record, my objections to Keynesian modeling does not any way mean I accept “supply side economics,” or any of the snake oil the Republicans are pushing. Unfortunately the Democrats are pushing another variety of snake oil, one which might turn out to be even more toxic.

A. Zarkov:
How do you know (partial) dY/dG is constant, and not a function of time and other variables? As I said this whole argument rests on an equilibrium model. But more fundamentally there is a problem with the macro economic approach to the economy. Modern quantitative economics has been made to look like physics. This comes from Samuelson, who was influenced by Edwin Wilson who was a protegé of Willard Gibbs. Samuelson explicitly acknowledged the influence of Gibbs thermodynamics on his work– see here. Now ask yourself, “can we really capture the workings of an economy in a few macro state variables? Is all government spending simply reducible to a variable G? Do you really think having the government build a pyramid produces the same ultimate effect on an economy as building a harbor? I don’t think the abstractions used in macro economics are all that useful. How many economists say the housing bubble collapse? How many predicted the downturn in the economy? Almost none. This alone should tell you something is rotten in Denmark.

There are a number of questions and remarks here. I’ll try to reply to them in order.

- You don’t. You’re welcome to propose and estimate another equation. If we call the multiplier X, you can make it depend on whatever other variables statistics will let you.

- Equilibrium models are the best we’ve got. Whether that is better than nothing at all is a question for another day.

- These models can be made much richer. Instead of working with just one variable G, and one for consumption and investment, you can define many sub-variables, as long as they’re observable. Outside the world of Keynes, the big guy on this type of thing is Nobel prize winner Wassili Leontief, who ran analyses on hugely detailed datasets describing the economy with very little ex ante modelling. Unfortunately, his input/output approach has the key flaw that it requires all the parameters in the matrix to be constant. (Although some economists have been trying to fix that in recent decades.)

- I’d be the last person to advocate an economics-only approach to government policy, even government economic policy. For example, I’d suggest spending stimulus money – if any – on things that are independently useful, such as the Hoover Dam. Even if the economic analysis is wrong, you’d still have a cool dam. Economic science will never be as precise as physics, and it is wrong to even try. (In my dissertation, I only use math as a convenient shorthand to state certain propositions. I’d never claim the math “proves” anything.)
The results of the study under discussion here can never be applied to the current recession in a mechanical manner. To the extent that the current problems are unprecedented, the analogy is completely invalid. Nevertheless, as long as they are well done, such statistical studies are a valuable way of learning from the past. (Apply with care!)

I have not expressed any opinion on whether or not we can “expect” a multiplier > 1.

In fact, I also haven’t expressed an opinion on whether this stimulus is a good idea.

Sorry, I guess I misunderstood you.

ShelbyC:
Yup.Kinda like pointing a gun at two people and making them pass a $100 bill back and forth.Fat lot of good it does ya.

Actually, that one has a multiplier of exactly one: it neither hurts nor harms the economy.

If $100 dollars gets taken at gun point from one person and given to another, the impact on the economy depends, analysed using Keynesian economics, depends on their relative marginal consumption quote. Quoting wiki because I’m too lazy to type it all out myself:

In a closed economy, the IS curve is defined as: Y = C \left({Y}-{T}\right) + I \left({r}\right) + G, where Y represents income, C(Y − T) represents consumer spending as a function of disposable income (income, Y, minus taxes, T), I(r) represents investment as a function of the real interest rate, and G represents government spending. In this equation, the level of G (government spending) and T (taxes) are presumed to be exogenous, meaning that they are taken as a given. To adapt this model to an open economy, a term for net exports (exports, X, minus imports, M) would need to be added to the IS equation. An economy with more imports than exports would have a negative net exports number.

In case the equation doesn’t survive: Y = C(Y-T) + I(r) + G. This is your basic linear Keynesian real economy equation. (The other one, LM, describes the supply and demand for money.) As you can see, the Y appears twice, once on the left and once on the right. The question analysed in the OP is what happens to Y if you increase G by one dollar. As I tried to explain before, the trickle goes in a number of steps. (Theoretically, a Zeno-style infinite number of steps.)

G goes up by one dollar.
Y goes up by one dollar.
C goes up by c dollars, where c is the marginal consumption quote.
Y goes up by c dollars.
C goes up by c^2 dollars.

So far this is all great, and the total output seems to increase by much more than one dollar. Unfortunately, the increased spending has to be paid somehow. Deficit spending implies a shift to the right of the IS-curve, meaning a higher interest rate and lower investment. A tax increase implies a higher T in the equation above, which creates the same trickle as before, only in the opposite direction.

Whichever way the increase in government spending is paid for, the way that it is spent partially or wholly undoes the effect of the increase in spending itself. As a result, the net effect of a fiscal impulse cannot be predicted from the model alone, it requires empirical study, which is exactly what Barro & Redlick have done.

Martinned:
The multiplier is simply the dY/dG partial derivative. You can make the model as complicated as you like, but as long as it can be expressed mathematically, a multiplier can be estimated. And however you estimate it, the question is whether it exceeds one, not zero.

How do you know (partial) dY/dG is constant, and not a function of time and other variables? As I said this whole argument rests on an equilibrium model. But more fundamentally there is a problem with the macro economic approach to the economy. Modern quantitative economics has been made to look like physics. This comes from Samuelson, who was influenced by Edwin Wilson who was a protegé of Willard Gibbs. Samuelson explicitly acknowledged the influence of Gibbs thermodynamics on his work– see here. Now ask yourself, “can we really capture the workings of an economy in a few macro state variables? Is all government spending simply reducible to a variable G? Do you really think having the government build a pyramid produces the same ultimate effect on an economy as building a harbor? I don’t think the abstractions used in macro economics are all that useful. How many economists say the housing bubble collapse? How many predicted the downturn in the economy? Almost none. This alone should tell you something is rotten in Denmark.

ShelbyC: @Martinned, I don’t understand.You seem to be arguing that the multiplier will be > 0, but I don’t think anybody disagrees with you about that.And I’m missing the part of your arguement that shows that we can expect a multiplier > 1.

That not an “argument” issue, it’s an empirical one. I haven’t reviewed the study of the OP (yet), and while I am an economist, I am not a macro-economist, and I have done no work in the area myself. All I’ve been trying to do is explain what it is these guys actually did, and why that matters.

One of the reasons why this matters is that a multiplier greater than 1 is certainly within the realm of possibility. In fact, it is an underlying assumption of the entire stimulus plan. I have not expressed any opinion on whether or not we can “expect” a multiplier > 1.

In fact, I also haven’t expressed an opinion on whether this stimulus is a good idea. Whatever the multiplier, I agree with an earlier commenter who remarked that such fiscal stimuli usually work too slowly to do any good. During a normal recession, a stimulus usually kicks in just about when the business cycle is at the top of its next boom, thus contributing nicely to the overheating of the economy at that point. It follows that, again, the question is whether this recession is sufficiently different from past recessions, and I am far from convinced that it is.

…forced spending increases economic activity.

Yup. Kinda like pointing a gun at two people and making them pass a $100 bill back and forth. Fat lot of good it does ya.

Why would that be bad? The point is to put money back into the economy, to get the producers producing again. Whether those producers produce investment goods or consumption goods isn’t that important.

I think this completely fails to appreciate why the economy collapsed. The economy collapsed because a whole bunch of wealth suddenly ceased to exist.

If I had a $650,000 home, and a $500,000 mortgage, that’s a ton of value. I can buy a plasma TV, and I can take vacations. My mortgage can be securitized and traded like cash and used to buy things.

Suddenly, the $650,000 home becomes a $350,000 home and the mortgage becomes worthless. Now I can’t afford a plasma TV and can’t retire.

The problem is that there are plasma TV factories building plasma TVs that nobody is going to buy. Their employees have jobs doing something useless.

The fix is to stop making plasma TVs. The fix is to stop making the goods that only made sense to make in an artificially-inflated economy.

Just pumping more money into the economy, into different goods than the goods currently being consumed, just creates a double whammy. There’s still nobody buying those plasma TVs, so those companies still collapse. But those displaced move into economic sectors that don’t make sense in the long term, which was the problem in the first place.

ShelbyC: a) so?b) sounds like the theory that Henry Ford made money by paying his car workers more so they can buy his cars.c) I don’t but the same arguments apply to non-investment spending.

Investment creates disposable income for those involved in producing the investment goods. Some of that disposable income is consumed, some of it is saved. Saved money is lent or invested, either way, it ends up paying for more investment. It doesn’t matter where you start in the cycle, at least not very much. (The exact form that a fiscal impuls in the economy should take is one of the questions studies like the one in the OP attempt to answer.)

Say the government spends money on combat planes, since apparently defence spending has a higher multiplier. That money goes to the employees of Boeing, to its suppliers, to its bankers, back to the government (corporate income tax) and to its shareholders. With the exception of the government, all these people consume some of the money, invest some of it, save some, etc. etc. etc.

BTW, Henry Ford’s employees probably did buy more cars as a result of receiving a higher wage. And if they didn’t, maybe the local store owners did. It would definitely be possible to estimate a multiplier there, only it would probably come out very low, if not statistically insignificant. The numbers might come out something like: For every $ 1 million more spent on wages, Ford sells one additional car, worth $ 1000 in profit. The multiplier is therefore 0,001, which is greater than zero but less than one, meaning that – duh – this is a bad idea.

A. Zarkov: Martinned:You seem to be saying that any spending is good spending. If the government prints money and hires 8 million people to dig holes in the ground and another 8 million to fill up the holes then the secondary effects will at least offset the costs– future inflation? If that’s the case then why is Zimbabwe (Rhodesia) such a basket case? Your conclusion from the multiplier defies all common sense, and shows the conclusions one can get with linear equilibrium models of the US economy. The real economy is non-linear with feedbacks and rarely in equilibrium. The think the multiplier is a red herring.

Let me say it one more time: Virtually all government spending has a multiplier greater than zero; it adds something to the GDP/TVA. The relevant question is whether the contribution is greater than the cost, i.e. whether the multiplier is greater than one.

This argument applies equally if one prefers non-linear models. The multiplier is simply the dY/dG partial derivative. You can make the model as complicated as you like, but as long as it can be expressed mathematically, a multiplier can be estimated. And however you estimate it, the question is whether it exceeds one, not zero.

a) Because it’s not the same person.
b) Because they now have increased consumption to give them a reason to invest.
c) And again: Why do you care about investment over other elements of national product/TVA?

a) so?
b) sounds like the theory that Henry Ford made money by paying his car workers more so they can buy his cars.
c) I don’t but the same arguments apply to non-investment spending.

You seem to be saying that any spending is good spending. If the government prints money and hires 8 million people to dig holes in the ground and another 8 million to fill up the holes then the secondary effects will at least offset the costs– future inflation? If that’s the case then why is Zimbabwe (Rhodesia) such a basket case? Your conclusion from the multiplier defies all common sense, and shows the conclusions one can get with linear equilibrium models of the US economy. The real economy is non-linear with feedbacks and rarely in equilibrium. The think the multiplier is a red herring.

Why would they be more likely to invest it than the folks you took it from in the first place?

a) Because it’s not the same person.
b) Because they now have increased consumption to give them a reason to invest.
c) And again: Why do you care about investment over other elements of national product/TVA?

The point is to put money back into the economy, to get the producers producing again.

From where?

if producers of consumption goods make more money as a result of the stimulus, they are going to invest some of that money.

Why would they be more likely to invest it than the folks you took it from in the first place?