The Triangle

Issue date: 2/13/09 Section: Ed-Op

Media Credit: Terrence Antonio James Chicago Tribune/MCT

There is currently a debate ranging among first-rate economists and among politicians on the potential effectiveness of the $820 billion fiscal package suggested by President Barack Obama to stimulate the U.S. economy. This package includes a $550 billion increase in spending for local, state and federal government projects and $270 billion in tax cuts over two years, with the aim of creating three to four million new jobs. While the debate involves both the spending hike and tax cut components, the package is viewed by political and economic conservatives to be unreasonably skewed towards more government spending and fewer tax cuts.

Government Spending Multiplier

The stimulus debate concentrates basically on the values of the government spending and tax multipliers. Some conservative economists use the GDP identity:

GDP = Consumption + Investment + Government Spending + Exports - Imports to deem the package, in their opinion, unsuccessful. Those who subscribe to the notion, such as John Cochrane, claim a one unit increase in government spending results in a one unit decrease in private spending (consumption and investment), leaving GDP unchanged. This can also be described as a government spending multiplier of zero.

On the other hand, Suzan Woodward and Robert Hall argue that this multiplier is one - that a unit hike in government spending produces a unit increase in GDP. In terms of Obama's spending figures, this means the government spending hike will increase GDP by $550 billion over two years - equal to the total spending component in the package.

Since the package includes funds that will immediately go to the pockets of consumers, as well as money for long-run infrastructure projects, it should lead to even more than one unit GDP increase.

It is true that infrastructure projects take time to be implemented, and in that aspect they are late in creating jobs and stimulating the economy. However, they bear sweet fruits in terms of increasing economic growth and efficiency in the long run, if they are not sugar-high projects. In the multiplier language, this means that the infrastructure multiplier is low and slow in the short run, but it should be greater than one in the long run, particularly if the economy is in a recession where not all resources in the economy are in use, and the crowding out of private spending by government spending is minimal. The recent estimate by the Congressional Budget Office of the cumulative multiplier over several quarters of funds transferred to local and state governments for infrastructure, ranges between 1.0 and 2.2. These figures imply that an increase in government spending on infrastructure could increase GDP by up to 2.2 times the original increase.

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