This is just a post about Keynesian mulitpliers with no particular religious content. You have been warned and forewarned.
The current excitement over stimulus has roots in the following idea: The government pays a dollar to Harry for services, he saves some of that and spends the rest to buy something from Anna, who does the same by buying from Carlos, ad infinitum. Thus one dollar of “stimulus” does the work of multiple dollars for helping the economy. So far, so good.
Naturally, some people want to spend the money and some want to cut taxes. In Slate, Daniel Gross writes a little piece on why a tax cut will be less effective than a spending increase. The argument is, literally, textbook, if people aren’t spending extra money, then a tax cut will provide no stimulus because people just pocket the money (this is clear from the theory, although one of Obama’s brighter economists has a paper suggesting that, empirically, tax cuts actually help more than spending cuts– which would not be the first time theory has taken a blow from empiricism).
The sort of dumb part is that whenever I hear somebody talk about how the spending will be more powerful than the tax cuts because people aren’t spending, they fail to mention the obvious corollary — that spending stimulus’ effectiveness is intimately tied to the same thing. Go look at the story in the first paragraph — a lot of stimulus is supposed to come from the money that Harry and Anna and others spend. The less people are spending out of new income, the less the stimulus will affect anything. And given the excessive time lag on government spending — or the inherent waste and corruption from spending fast, the whole enterprise becomes rather dubious as a stimulus.
We’ve known all this for a long time, but Congress keeps at it because it’s good politics. Many people feel that the current situation is extraordinary and so calls for extraordinary action, which may be so. But there is no evidence that it is extraordinary in a way that would suddenly make fiscal stimulus a good idea.
If you have a broken leg, it is doubtful that a golden band-aid will help much. If you then have two broken legs and a tumor, don’t tell me that “extraordinary circumstances” call for the golden band-aid. There is no doubt circumstances are extraordinary, but you still need to figure out why you think a golden band-aid is the answer when it wasn’t before.