De­bat­ing Government's bang for its buck

The Pak Banker - - OPINION - Caro­line Baum

ECON­O­MISTS talk about the neg­a­tive im­pact from the $85 bil­lion of au­to­matic spend­ing cuts with such author­ity, you would think th­ese fore­casts were writ­ten in stone. Hardly. Th­ese are pro­jec­tions spit out by econo­met­ric models that are pre-pro­grammed with a spe­cific mul­ti­plier: a num­ber that re­flects the ef­fect of a $1 change in government spend­ing or taxes on gross domestic prod­uct.

For ex­am­ple, a $1 in­crease in the government's pur­chases of goods and ser­vices, one com­po­nent of GDP, trans­lates im­me­di­ately to $1 of out­put. Then what? That spend­ing be­comes some­one else's in­come. The hope is that en­tity will spend or in­vest a por­tion of it. The mul­ti­plier at­tempts to cap­ture to what ex­tent that ini­tial dol­lar boosts pri­vate-sec­tor growth. If the es­ti­mate of the mul­ti­plier is wrong, then the pro­jec­tion for the ef­fect of any given pol­icy is wrong. Long-dead econ­o­mists are still de­bat­ing the is­sue.

John May­nard Keynes said that in a de­pressed econ­omy, the fed­eral government could and should use deficit spend­ing to boost ag­gre­gate de­mand in the short run. To achieve a ben­e­fit, the mul­ti­plier only had to be greater than zero. (In other words, government spend­ing couldn't de­press pri­vate spend­ing and in­vest­ment.) Mil­ton Fried­man be­lieved mon­e­tary pol­icy could do the job with­out cre­at­ing mar­ket dis­tor­tions. He said the neg­a­tive ef­fects of fi­nanc­ing deficit spend­ing out­weighed the pos­i­tives. Friedrich Hayek was a fan of nei­ther form of in­ter­ven­tion. Given the di­a­met­ri­cally op­posed views on the im­pact of government spend­ing, what should we ex­pect from the $42 bil­lion in ac­tual cash dis­burse­ments in fis­cal 2013? (The non­par­ti­san Con­gres­sional Bud­get Of­fice says only half of the $85 bil­lion se­ques­tra­tion will be im­ple­mented be­tween March and Septem­ber.) The CBO es­ti­mates the cuts will re­duce the growth of real GDP by 0.6 per­cent­age point in this cal­en­dar year and de­press full-time job cre­ation by 750,000. The CBO's 1.4 per­cent real GDP forecast re­flects a 1.5 per­cent­age-point hit from the var­i­ous changes in tax-and-spend pol­icy that went into ef­fect this year.

When the CBO ex­am­ined the ef­fects of var­i­ous parts of the Amer­i­can Rein­vest­ment and Re­cov­ery Act, the $830 bil­lion fis­cal stim­u­lus en­acted in 2009, it found the mul­ti­plier was about one: $1 of fed­eral out­lays bought $1 of GDP. Or, to put it in lay­man's terms, there was noth­ing be­yond the first-round ef­fect.

Which shouldn't be a big sur­prise. The na­ture of a bal­ance- sheet re­ces­sion and its resid­ual of bad debt made delever­ag­ing, not spend­ing, a top pri­or­ity for house­holds and in­sti­tu­tions. The mul­ti­plier can be af­fected by the level of in­ter­est rates, the kind of ex­change-rate regime a coun­try main­tains, the de­gree of unuti­lized re­sources, and the amount of stim­u­lus that was al­ready put in place, ac­cord­ing to econ­o­mists Veronique de Rugy and Matthew Mitchell, se­nior re­search fel­lows at the Mer­ca­tus Cen­ter at Ge­orge Ma­son Univer­sity in Ar­ling­ton, Vir­ginia.

In a 2011 work­ing pa­per, de Rugy and Mitchell sur­veyed the aca­demic lit­er­a­ture and found a wide range of es­ti­mates for the spend­ing mul­ti­plier: from +3.7 to -2.9. They also found that high lev­els of debt de­pressed the mul­ti­plier in var­i­ous coun­tries. The CBO is the first to ad­mit that pre­dict­ing the ef­fect of any given pol­icy is an in­ex­act sci­ence that "would re­quire know­ing what path the econ­omy would have taken in the ab­sence of a given pol­icy ac­tion," an­a­lysts Felix Re­ich­ling and Charles Whalen wrote in a May 2012 work­ing pa­per.

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