Monday, January 12, 2009

About Stimulus Multipliers

Greg Mankiw has spend a lot of time in the past few days examining the multiplier factors in the upcoming stimulus package. You can read a summary in this Sunday's NY Times article, Is Government Spending Too Easy an Answer?

What I find interesting is that Obama's economic team released a paper which claims the multiplier is 1.57 for Government purchases and 0.99 for taxes. The report is authored by Christina Romer and Jared Bernstein. This is in line with Keynesian expectations which predict that the effect of Government spending has to be higher than that of tax cuts.

But reality is different, and Mr. Mankiw shows that research on past trends point to a spending multipler of about 1.4 and a tax multiplier of around 3. (What this means is that increasing spending by 1% will result in a GDP increase of 1.4%. Same way, cutting taxes by 1% as a share of GDP will boost the GDP by 3%). I think this difference is explained by the Laffer curve and the research was conducted when taxes were way much to the right of the curve.

Anyway, the interesting point here is that one of the papers that claim the 3.0 multiplier for tax cuts comes from David and Christina Romer, the same Christina Romer on Obama's team who now attributes only 0.99 to tax cuts. Mr. Mankiw thinks that Mrs. Romer's position as an adviser is the reason for an increased focus on tax cuts in Obama's plan, but it looks like she caved to the demands of his liberal base. The hope is that somehow the voices of reason will prevail and eocnomic decisions will be based on economists' suggestion, not on politicians'. From my discussions with one of Obama's advisors (although not on the economic team), the president-elect admits he has no clue about economy and will listen to what the experts say as long as it doesn't conflict too much with his extreme-left socialist cohorts. (well, those were not exactly his words, but that was the general idea).

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