kitchen table math, the sequel: help desk - fiscal multiplier

## Tuesday, July 5, 2011

### help desk - fiscal multiplier

We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound and the capital. The stimulus results in negative welfare effects for unconstrained agents. The constrained agents gain, if they discount the future substantially.
Fiscal Stimulus and Distortionary Taxation
Thorsten Drautzburg, Harald Uhlig
NBER Working Paper No. 17111
Issued in June 2011
NBER Program(s): EFG
I'm confused about the concept of the fiscal multiplier.

I've read explanations characterizing the multiplier as a simple multiple: if the multiplier is 1.5 and the government spends \$1 million, then the net spending beyond that \$1 million is \$500,000.

1.5 x 1,000,000 = 1,500,000

But that's not right, is it?

What does a multiplier of .52 actually mean in terms of what the public spends beyond the amount the government spent?

Anonymous said...

I think that the fiscal multiplier takes government spending as the input and has *NET* private income as the output.

A multiplier of 0.5 would mean that \$1M in government spending would eventually result in \$500K *profits* somewhere down the line (probably spread out over many individuals and companies).

A long-run multiplier of -0.5 would mean that the government spending \$1M *destroys* \$500K in profits down the line.

I don't know how to figure the extra activity (which, I think, is what you want) from an extra \$1M of government spending. The problem is that that \$1M that the government spent came from somewhere and would have been spent (or invested, but this usually leads to spending) anyway, just differently. I'm going to ignore the "printing money" effect for now.

You might care about the velocity of money as the multiplier you are looking for ...

-Mark Roulo

Catherine Johnson said...

That's exactly what I was wondering: are we talking about net private income as the output?

If so, then the 1.5 multiplier was supposed to produce a net of 1.5 million for every 1 million of fiscal stimulus, right?

Anonymous said...

"If so, then the 1.5 multiplier was supposed to produce a net of 1.5 million for every 1 million of fiscal stimulus, right?"

That is/was the claim.

I'm pretty sure that this is nonsense most of the time ... if it was true, then you could have a tax rate of 75%, the government would get back the \$1M with profit, and everyone would be better off [\$1.125M in taxes for every \$1M in government spending *AND* the private sector is also \$375K better off].

In some limited cases I think this is true (e.g. infrastructure spending up to a point, a decent legal system). In the general case, I don't see how it can be. Typically government spending is a net cost ... possibly a cost worth paying, but still a cost.

-Mark Roulo

ChemProf said...

The idea is that when the government spends money, much of it winds up as salaries. Those employees then buy stuff and spread their salary money through the economy. You see this argument often from public employees arguing that laying off public employees will hurt the economy.

However, these estimates usually assume that \$1 in government spending didn't cost anything -- in other words, it leaves out the fact that it costs the government more than \$1 to acquire \$1 in tax money (when you include enforcement of the tax code, processing costs, etc). There is also some evidence that government spending tends to crowd out private spending, which pushes down the multiplier (even if you believe in one).