Sunday, July 18, 2010

The Multiplier ... Yea, That's My Reason

Here in my state of Minnesota, we have a pretty large budget deficit, about 15% of spending, at $6.95 Billion for 2012. That's unsustainable long term. The Democratic candidate, Margaret Andersen Kelliher, is running on a program of increasing rspending by $2B to create jobs, but cutting $1B of 'fraud and waste. In other words, spending $2B more. The idea is that it 'would put 50,000 Minnesotans to work constructing roads, bridges and buildings'.

Given the logic of the multiplier, the government should always spend more. I think most people don't really have an opinion on the multiplier, rather, conservatives and liberals are more influenced by their appreciation or skepticism of government spending.


Dave said...


I asked you a version of this question in the last thread, but let's modify it for this post. Let's say whoever the next governor of Minnesota ends up being calls you up and asks you for your economic advice. What would you suggest?

Eric Falkenstein said...

Easy to say, hard to do. I'd simply cut spending by say 2% a year. In a few years, we would be in a balanced budget. Any large organization can go with 2% less, but I wouldn't micro manage that. As per particular programs I might want to single out, basically I'd say anything outside of transportation, parks, and legal, would be most targeted. Governments generally create make-work jobs, not real jobs, so I don't think government is better at spending money than the people who would keep it.

Dave said...

Definitely tough to do, but let's say you could. What about the Keynesians' argument that this sort of austerity would weaken the economy, thus lowering tax receipts and making it harder to balance the budget?

J said...

Dont cut the bridge (infrastructure) maintenance budget.

Drewfus said...

There's a fascinating 'real world' experiment going on in most of the EU right now. Budget cuts amount to much more than cutting expenditure at an annualized rate of 2%, so the Keynesian model is definately being put to the test.

If Europe doesn't seriously falter as predicted by most Keynesian economists, macroeconomics will require a major rethink - unless they can explain it away. On the other hand, a relapse into deep recession will more or less be a vindication of Keynesianism.

Drewfus said...

Given the logic of the multiplier, the government should always spend more.

What about at full employment? Wouldn't more spending at that point just be inflationary?

Plamen said...

Drewfus, two notes:

1) Gov't spending becomes (mostly) inflationary way before full employment. It becomes wastefully inefficient and corrupt way, way before it even becomes inflationary.
2) When was the last time a Keynesian said - as a policy recommendation for the future, as opposed to looking back to the past - "We are at full employment, we need to stop growing gov't spending." Keynesians have a normative tolerance for inflation that, ipso facto, makes attaining full employment via Keynesian spending a non-starter for any non-Keynesian. To these folks, everything is short run ("In the long run, we're all dead"), and in the short run the Phillips curve holds, sort of - they call it "expectations-augmented" nowadays. So they are willing and happy to beat us to (long-run) death with it - after all, it balances so nicely all those beautifully elegant dynamic stochastic general equilibrium models that they love.

Robert Johnson said...

Drewfus is right, of course.

When contrasting Govt. spending against consumer spending (i.e. why don't we just cut taxes so consumers will spend more) the textbook distinction between the two is that Govt. spending 1) reduces the savings rate, and 2) changes the mix of investment.

The reduction in the savings rate is why Govt. spending is supposed to have a larger multiplier than consumer spending.

What is less discussed is the potential impact on the mix of investment. If the Govt. taxes and spends on investment in education, roads, R&D, then potentially there will be less investment in, say, mini-mansions (non-producing investment that doesn't spur future growth in income), and more in things that help our long-term prospects.

The problem is that the Obama administration has not articulated any such aim, and in fact appears to be putting new spending toward consumption, not toward investment.

Eric Falkenstein said...

in real time, we are never at full employment--only with hindsight

Robert Johnson said...

Do you mean that we're actually not at full employment at the time, or just that it's difficult at the time to know whether we are at full employment?

Eric Falkenstein said...

those who like fiscal spending in general, always like fiscal spending! Either unemployment is too high, or 'real unemployment' (after you take out adjustments for people dropping out of the labor force, or in 'bad' jobs) is too high. I've never seen where the Liberal consensus, at any time, has ever said 'more spending is counterproductively inflationary right now'. With hindsight, sure, but never in real time, never 'now'.

Drewfus said...

Gov't spending becomes (mostly) inflationary way before full employment. It becomes wastefully inefficient and corrupt way, way before it even becomes inflationary.

Yes, i agree, although this reminds of the macro papers i've seen that have demonstrated inflation is statistically higher during recessions than during booms.

The trade-off seems to be between stagflation and growth, not inflationary growth and deflationary recession. However, this latter notion of how the macroeconomic world works seems to be the consensus, at least at the level of economic commentary. The problem is that it doesn't fit the data too well.

My hypothesis is; the Keynesian 'worldview' of seasawing inflation and underemployment is popular, not because it is correct (or totally so), rather that it implies a simple management mechanism - deficits and low interest rates for recessions, surplus's and higher rates when and if we ever hit full employment and high inflation. It implies mastery of our own destiny, which is the key to its political favoritism.

Robert Johnson said...


I totally missed what you were saying. You go to fast for me, man!

Yeah, I think you might be right about that. Some people make economic-sounding arguments to justify the spending that they want to do anyway.


As a politician it's a hard sell to say, 'I can't fix the recession, but I'll give you sound governance and we can all hope for the best.' Especially when your opponent promises to have the recession fixed early next month.

Drewfus said...

Obviously true.

My point was simply to be conscious of the fact that what expert's like Krugman are selling, is not their skills and knowledge, its their authority.

Putting it more bluntly - what does the world do better, because of Paul Krugman, other than to express greater confidence in Keynesian spending programs?

Now that is not just cynicism on my part. Social structures are hierarchical in nature, and the top of any hierarchy has to be taken on trust, at least in part. The purpose that spokespeople like Krugman play in our society in to develop and maintain confidence in our leading decision makers, to justify that necessary but largely implicit trust.