Fiscal Multiplier Debate

I had earlier pointed to an excellent interview of Robert Barroon Fiscal Multipliers and Paul Krugman. In a new interview he says the same things – fiscal multipliers are less than one (which means not a multiplier at all) and also lists a reading list on Great Depression.

His take on fiscal multipliers:

You know one of the things I’ve been trying to do in my research is to calculate the effect, particularly on Gross Domestic Product, of government expenditure programs. And I’ve been focusing on the US experience, because that’s where I have the information, although it would be good to go beyond that. But the thing you can really clearly isolate is the effect of wartime expenditure. Particularly World War II  – it is so big that in a statistical sense it gives you a lot of power to figure out what is going on.

There’s both the buildup, starting in 1941, and then there’s expenditures coming down after the war, in 1945-6. There’s a lot of evidence there. Sometimes the spending in a year is 20% of GDP, which is absolutely astounding. So in comparison, the New Deal programs, particularly in 1934 and 1936, they’re only 2-3% of GDP of extra spending.

So it’s hard to sort it out. I’ve been trying to do that, but in terms of the stuff that’s not wartime spending–which we’re probably most interested in in the current climate–it’s just hard to know from the history of the data and the time series. The New Deal is part of my research, and it’s bigger than the other non-defense expenditure in terms of stimulus, but it’s not enough to really sort it out.

So I don’t think you can reliably say what the effect is. But conceptually you’d expect the wartime spending to have a bigger effect for various reasons on the GDP than the equivalent amount of expenditure in a non-war situation. And the wartime effect you can estimate pretty precisely and the multiplier is clearly less than 1, even in World War II – in the order of 0.6, 0.7 something like that.

This time he takes on Christy Romer:

B: And yet neo-Keynesians—which include White House economics adviser Christina Romer–often cite the number as being 1.5, and you say in your article that the Obama administration is using 1.5 as a basis for its fiscal stimulus policies. How do they come up with that then?

RB: Oh they pulled that out of the air. I have the advantage of having at least a little bit of empirical evidence, as I said, it’s based particularly on military purchases. So even though that evidence is not that great, it’s infinitely better than the alternatives, which are no evidence. I think Valerie Ramey’s work is the best in terms of empirically trying to figure what the effect is of expenditure on the macro-variables. She has focused mostly on the post-World War II period, but she’s looked somewhat at the earlier part.

All this is so confusing. We are in the middle of such a huge crisis and we still do not know what works. I have read a bit of Romer and was initially surprisedthat most of her research says mon pol works in all crisis (Barro also says the same) but she advocates fiscal stimulus in her plans.  Later in a speechat Brookings she clarified:

I wrote a paper in 1992 that said that fiscal policy was not the key engine of recovery in the Depression. From this, some have concluded that I did not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be further from the truth. My argument paralleled E. Cary Brown’s famous conclusion that in the Great Depression fiscal policy failed to generate recovery, not because it does not work but because it was not tried.

So, because fiscal stimulus was not tried which was a broad conclusion. On a closer look at another Romer paper one gets the same conclusion – fiscal policy was not tried much and mon policy helps in most of recession cases. But, then we had another paper from neo-Keynesian economists which said Romer had overestimated the fiscal multiplier and the actual number was much lower. It isn’t just a divide. It is a huge difference in terms of estimations as well. Barro, John Cochrane and a host of others say fiscal stimulus does not work. Then we have equal prominent names like Paul Krugman, Brad delong, Christy Romer, IMF (the biggest surprise)  who say it does work.

Anyways, I am reproducing Barro’s reading list:

1. Milton Friedman and Anna Jacobson Schwartz, Monetary History of the United States 1867-1960The chapter specifically on the Great Depression was republished last year as The Great Contraction 1929-33. Ground-breaking work that prompted Ben Bernanke’s apology to the authors, on the Federal Reserve’s behalf, at Friedman’s 90th birthday party: I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again. Bernanke’s speech is also a great summary of Friedman and Schwartz’s book.

2. Ben Bernanke,Essays on The Great DepressionQuest to understand the Great Depression, in Bernanke’s words, the “holy grail of macroeconomics.”


3. Harold Cole and Lee Ohanian, The Great Depression in the United States from a Neoclassical Perspective
4.Harold Cole and Lee Ohanian, New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis A look at FDR anti-market policies.
5. Robert Barro, Government Spending Is no Free Lunch
6. Robert Barro, Demand Side Voodoo Economics Serious economist on why the stimulus plan was a mistake
7. Valerie Ramey, Identifying Government Spending Shocks: It’s All in the Timing Pinning down that elusive Keynesian multiplier

Books by Robert Barro
1.  Nothing is Sacred: Economic Ideas for the New Millennium  and  Getting It Right: Markets and Choices in a Free Society(2002) High accessible, based on Barro’s WSJ and Business Week columns
2. Macroeconomics: A Modern Approach (2008) Undergraduate textbook, real business cycle (anti-Keynesian) approach. 
3. Economic Growth (2004) Popular in graduate seminars i.e. not for the lay reader
4. Determinants of Economic Growth(1998) More accessible book on economic growth.
 5. Money, Employment and Inflation(2008) Throwback to Barro’s youth, when he was still working on improving the Keynesian model. Republished last year in paperback.
6. Currency Unions (1999) 

1. Rare Disasters and Asset Markets in the Twentieth Century: A look at why equity returns are higher than bonds. Short answer: because you regularly lose all your money. 2. Macroeconomic Crises since 1870 
3. Stock Market Crashes and Depressions
 4. “What are the Odds of a Depression?Answer: 20%

4 Responses to “Fiscal Multiplier Debate”

  1. Elli Says:

    Great article and great blog, I thought the economist’s view and Cafe Hayek are the best, but I think I will put your there immediately 🙂

    This multiplier thing reminds me times when I studied macroeconomy from some book my university recommended (I didn’t care so much about it so now I don’t remember at all who was the author) and all these Keynesian ideas have been presented there like natural laws and all students (and unfortunately teachers too) automatically accepted them. This is the problem of economy. All (almost) schools are trying to present their results as a natural law. Then we see the government administration accepts 1.5 multiplier as the basid truth, like water boiling at 100 C….
    Take care

  2. Six principles for Fed-Treasury Accord « Mostly Economics Says:

    […] conference). As a result, we get fiscal multipliers much lower and it is not a multiplier at all (see this for a review). However, if we take a zero bound mon pol situation, fiscal multiplier is much larger (though I […]

  3. A primer on fiscal multipliers « Mostly Economics Says:

    […] primer on fiscal multipliers By Amol Agrawal I had earlier written a post on fiscal multipliers expressing frustration that we still don’t know whether there is a […]

  4. world cities Says:

    nice post.. thanks

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: