Becker and Murphy on the Stimulus

Josh Wright —  10 February 2009

I’ve got the over-under on Krugman name-calling directed at both set at noon EST tomorrow. Any takers? Anyway, here’s some key excerpts from the WSJ piece:

In a full-employment situation, increased government spending would largely replace private spending, so the net stimulus to GDP would likely be quite small. In the present environment, however, with growing unemployment of both labor and capital, the net stimulus would be larger since the additional government spending would put some unemployed resources to work.  For example, if the government spent money to build new homes with unemployed labor, the stimulus to GDP might be close to, even larger than, the amount spent. However, given the present housing glut, that hardly seems to be a wise policy, although it is a small part of both the House and Senate stimulus packages.

In fact, much of the proposed spending would be in sectors and on programs where the government would mainly have to draw resources away from other uses. This type of spending includes adding broadband to rural areas, spending more on health coverage, encouraging scientific innovations, developing renewable energy, as well as many other things.

So our conclusion is that the net stimulus to short-term GDP will not be zero, and will be positive, but the stimulus is likely to be modest in magnitude. Some economists have assumed that every $1 billion spent by the government through the stimulus package would raise short-term GDP by $1.5 billion. Or, in economics jargon, that the multiplier is 1.5.  That seems too optimistic given the nature of the spending programs being proposed. We believe a multiplier well below one seems much more likely.

Whatever the merits of other government spending, the spending in this package is likely to have less value. A very large amount of money will be spent quickly over a two-year period: $500 billion amounts to about one-quarter of the total federal government annual spending of $2 trillion. It is extremely difficult for any group, private as well as public, to spend such a large sum wisely in a short period of time.

In addition, although politics play an important part in determining all government spending, political considerations are especially important in a spending package adopted quickly while the economy is reeling, and just after a popular president took office. Many Democrats saw the stimulus bill as a golden opportunity to enact spending items they’ve long desired. For this reason, various components of the package are unlikely to pass any reasonably stringent cost-benefit test.

….

The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy….

Our own view is that the short-term stimulus from the legislation before Congress will be smaller per dollar spent than is expected by many others because the package tries to combine short-term stimulus with long-term benefits to the economy. Unfortunately, short-term and long-term gains are in considerable conflict with each other. Moreover, it is very hard to spend wisely large sums in short periods of time. Nor can one ever forget that spending is not free, and ultimately it has to be financed by higher taxes.

4 responses to Becker and Murphy on the Stimulus

  1. 

    “But since Bush’s neo-Hooverian approach failed miserably, so shouldn’t we at least try something else?”

    Fair enough. But why try the approach that failed for FDR? Or the one that failed so miserably for Japan in the 90s?

  2. 

    The over-under is that the name-calling will start before or after 12 noon EST tomorrow. Really, it should be a before/after rather than over/under, but you get the point. Well, its already almost 4pm EST so the after is getting more and more tempting. Maybe Krugman hasn’t seen his WSJ yet.

  3. 

    Maybe I’m missing something, but I don’t understand why the short-term and long-term gains are “in considerable conflict with each other.”

    If the short-term effects help stimulate the economy, won’t that increase the size of overall GDP to tax in the future? It looks to me like Becker and Murphy are assuming what they want to prove.

    To be fair, it also seems that one could make the same objection to supporters of the stimulus.

    But since Bush’s neo-Hooverian approach failed miserably, so shouldn’t we at least try something else?

  4. 

    Whats the over/under and which are you taking?