The rationale behind an economic “stimulus” is that recessions or depressions are caused by a lack of aggregate demand. Because of this, governments step in to speed up the recovery by using deficit spending to make up for the decreased aggregate demand. An economic term called the “Keynesian multiplier” predicts that for every dollar spent by the government, output will rise higher than a dollar because people continue to spend the money they get in exchange for their goods and services (and save the other portion). But how successful has the last stimulus really been?
In a recent op-ed in the Wall Street Journal, Robert J. Barro and Charles Redlick, using observations from a paper that will be published soon, write:
The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller.
If this multiplier is less than one, the government is spending more than it is helping. This deficit spending is more than just inefficient, it actually crowds out investment by raising interest rates, and creates the obvious problem of long-term interest payments.
The vast majority of economists say that this economic crisis has reached its bottom in terms of output (though unemployment will continue to grow). At the same time, only 10% of Obama’s stimulus package has been spent. 10%! If we’re already on the upswing, I propose we just forget about spending the other 90%.
Barro and Redlick did briefly mention another way to stimulate the economy:
…there is empirical support for the proposition that tax rate reductions will increase real GDP.