A Short Lesson on Multipliers

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.

50 comments for “A Short Lesson on Multipliers

  1. February 13, 2009 at 12:17 pm


    Hooray for an economics post! (from one economist to another)

    Yours is an oft-needed explanation for many. I had hoped you’d include some mention of crowding out, though, as I’ve always found this to be one of the most misunderstood and unknown problems with non-economists in understanding the impact of fiscal policy.

    Tax cuts are a little more straight forward–everyone can understand generally what “in theory” will happen if you give us all more cash, but the secondary effects of fiscal policy on private investment are more subtle, but certainly important.

  2. Julie M. Smith
    February 13, 2009 at 12:29 pm

    Frank, thanks.

    One thing that seems odd to me: for decades, people have kvetched that Americans do not save enough money. Of course, now that they are scared, they are saving every penny they can . . . which is causing further economic trouble.

    Is there any way out of this bind? In other words: any good ways to get people to save more when times are good and spend more when times are bad, when they want to do the opposite?

  3. February 13, 2009 at 12:44 pm

    Julie M.–

    The first thought off the top of my head is that reducing the tax rate on saved income would be a good start. Individuals in high earnings years could reduce their personal tax burden by saving more. In years when incomes are lower, such tax savings would be relatively less important and consumption would win the day.

  4. February 13, 2009 at 12:49 pm

    Frank, one interesting note on this is that many countries have learned that cutting taxes, especially corporate tax rates, income tax rates and taxes on capital gains, does stimulate activity more effectively than stimulus spending. Ireland, Estonia and many other countries learned during the 1990s that lower tax rates attracted jobs.

    At the same time, the biggest economic booms of the last 40 years were started by tax cuts (Kennedy, Reagan, etc).

    I wish this were not such a partisan and class issue — ie, tax cuts only help the “rich.” The working poor are the ones who are being hurt most during our current downturn and they are the ones who are likely to suffer most during the inevitable inflation that is likely to come in the next year or two from all this deficit spending (inflation taxes a larger percentage of the working poor’s income).

  5. Last Lemming
    February 13, 2009 at 12:56 pm

    It’s not really about spending increases vs. tax cuts per se. Either can be designed to provide a short-term Keynesian stimulus driven by consumer spending or a longer-term stimulus driven by saving. The big tax cut in the stimulus bill–a credit for the first $800 of payroll tax payed–is a relatively Keynesian tax cut because it can put money in workers’ pocket immediately and goes to those who are most likely to spend, rather than save, the money. A supply-side tax cut, like lowering the top marginal rate, is not stimulative in the short run because it is designed to get people to save rather than spend.

    Economists are still arguing over how (or even if) the 2001 tax cuts shortened that recession. The higher child credits, for example were designed to provide a Keynesian short-term stimulus while the lower marginal rates were designed to provide a longer-term supply-side stimulus. Which one made the difference? (Probably neither, but let’s not go there).

    You can make the same distinction with spending. Extended unemployment benefits and food stamps are examples of Keynesian stimulus. The spending on clean energy and medical records are designed to be more of a long-term stimulus by reducing costs (both internal and external). the highway spending is frequently characterized as a Keynesian stimulus, but unless the projects are truly “shovel-ready”, they are more of a long-term thing.

    To answer Julie’s question, when politicians and the public are able to distinguish between the long-term and short-term tools available to them, they might be able to design policies that that provide the right incentives at the right time. But don’t hold your breathe.

  6. February 13, 2009 at 1:25 pm

    Robert J. Barro goes after the idea that $1 of government spending = $1.50 of output.

    The big problem with tax cuts today is that nobody is spending and the credit markets are frozen. We have more money in our pockets from the tax cuts and save, banks save, corporations save, and those that want to spend can’t get credit to spend. Gotta love the credit economy.

  7. Adam Greenwood
    February 13, 2009 at 2:17 pm

    Ninja-ed! I was gonna post on this, except without the insights or facts or or opinions. But I didn’t post on it, because I passed out from holding my breath.

  8. jay s
    February 13, 2009 at 2:35 pm

    Geoff – some good points. I agree that tax cuts generally don’t help those in the lower tax brackets as much, and they are the most likely to be affected during inflationary times. With the exception that those with high debts and low assets are benefited during inflationary periods, but not likely enough to offset the stagnant salaries.

    also you referenced the low tax rates of ireland and estonia as growth modifiers. This is true, but not the whole picture. Ireland was also attractive because if its relatively low wages, and relatively highly educated labor force. A company could pickup from London or Massachusetts and go to an english speaking country with similar norms and lower wages. But as wages have risen in Ireland, their competitive advantage has diminished. In the United States Nevada exhibits similar phenomenon. Almost non existent business taxes, no income tax and a relatively low cost of living let business come here for cheap and pay moderate salaries, yet attract more people. The housing boom – raising housing prices beyond the reach of the average wage earners grasp – killed the people moving here, and killed the competitive advantage Nevada had.

  9. Mike McBride
    February 13, 2009 at 4:04 pm

    I think we should call them fractioners if the multiplying effect is less than 1.

    You said: “But there is no evidence that it is extraordinary in a way that would suddenly make fiscal stimulus a good idea.”

    I guess I’d say that evidence is in the eye of the beholder. The extremely low interest rates set by the Fed, the threat (though probably not likely) of deflation, a possible liquidity trap… these are the things that lead some to argue in favor of fiscal stimulus. I guess you don’t see this as evidence. Dont’ get me wrong; I’m not criticizing. I’m not really sure what I see. But I think it’s more accurate to say that you are not convinced by what others see as evidence.

    But I do disagree with Last Lemming. I think a big part of the issue is in fact whether it should be an increase in spending or a cut in taxes. Though a simple macroeconomic model implies that one can be done in a way with equivalent results as another, these models obviously lack the public choice messes involved with govt spending.

  10. Mark D.
    February 13, 2009 at 4:07 pm

    It is called a “correction” for a reason. The root cause of our troubles is that people have been borrowing and spending beyond their capacity to repay. The government borrowing and spending and taxing more cannot fix that problem, at best it can provide an expensive bandaid that transfers wealth from the average citizen to the politically well connected.

    Suppose instead the government issued credit cards with a $9,000 limit to each American household and said if you don’t spend up to the limit in the next couple years we are going to bill you for the difference anyway. Would the obligation for the average American household to spend $9,000 now and pay back $12,000 (including interest) later improve the economy on anything but the shortest of short run bases?

    I don’t think so. However, at least this alternate version would have the version of letting the public borrow and spend and repay on behalf of things they actually want and need rather than being forced to borrow and spend and repay for a collection of government programs of dubious real value.

    With temporary tax cuts the advantage would be even clearer – even if everyone just used the savings to reduce their outstanding debt, the reduction in that very debt burden would go a long ways towards eliminating the very condition that is causing the recession in the first place.

  11. Mark D.
    February 13, 2009 at 4:12 pm

    “would have the advantage of” of course.

    I might add that I find it amazing that any educated economist can invoke Keynesian arguments with a straight face after a generation of such policies led to ruinous conditions Keynesians said were impossible in the late 1970s.

  12. dh
    February 13, 2009 at 4:21 pm


    My worry is not that the stimulus will be impotent, but that its effect (coupled with $2T of liquidity already injected into the economy by the Fed and $750 Billion by Congress to the banks) will temporarily stave off the ultimate correction and make the eventual market correction harder to bear.

    We keep buying things with money the government doesn’t have and with money we don’t have. A dollar used to represent value already created. Now it is an IOU to the Anna’s and Harry’s of the world in hopes that they will get to work and create some value and then so on and so on until the original cost is lost in the zeros of a humming economy.

    But if the Anna’s and Harry’s of the world turn around and spend the borrowed funds, plus a few more borrowed funds from their credit cards, the whole credit crisis will get started all over again. Call me crazy, but part of me is more worried about eventual inflation than the current recession. I think we have too much phony money chasing too few goods and services. Granted, I don’t want you or me to lose our jobs or get taxed to death, but at some point somebody is going to have to pay for our prosperity. Who?

    I’m not economist. Will one of you smart folk please weigh in and critique what I have said?

  13. Aaron
    February 13, 2009 at 5:11 pm

    Funny how everyone suddenly is worried about government spending. Where was everyone during the past eight years when we pushed billions down the rathole of Iraq?

  14. February 13, 2009 at 5:18 pm

    “I might add that I find it amazing that any educated economist can invoke Keynesian arguments…”

    I don’t know if I invoked anything so much as commenting on a semi-contradictory position.

    Mike, that’s right. Some smart people think stimulus would be a good idea and they see stuff that convinces them of that. What strikes me as funny are people who think stimulus is a great idea, but scoff at tax cuts because of the purported low marginal propensity to consume, while failing to see, or at least point out, the damage that does to an argument for any kind of fiscal stimulus– tax or spending.

  15. February 13, 2009 at 5:22 pm


    1. This is not a generic post about spending, but rather about the likely ability of spending to end a recession.

    2. Take a look at this picture to get an idea of the deficit spending this year compared to years past. Maybe that will help you understand.

  16. DavidH
    February 13, 2009 at 5:34 pm


    1. I could not get the picture to open. Don’t know if it is my machine or the link.

    2. What is your take on the projected $2.5 trillion fix for the banking system?

  17. Jeremy
    February 13, 2009 at 5:42 pm

    Could someone explain a particular part of this problem to me? (This is an honest request; I’m not being snarky.)

    We hear a lot about how consumers’ individual overextension (mortgages they can’t afford, high credit card debt, etc.) have contributed to the current mess we’re in. But we also hear a lot about how exotic investment vehicles (Credit Default Swaps, etc.) magnified the problem multiple times over because they based several dollars of pretend value on one dollar of real value.

    It seems that both of those things are to blame — but in what proportions? In other words, how much value has been sucked out of the economy because of mortgages not paid vs. investments/insurance policies/etc. based on those mortgages?

    The reason I ask, is because when people express concern about stimulus spending and the debt it will incur, it is often couched in terms of “that’s what got us into this mess,” in a sense connecting up burdensome private consumer debt with government debt. I’m honestly trying to figure out the extent to which that’s actually true.

    Frank: the link in comment #15 appears to be dead.

    Also: can we bring the $1.6 trillion Bush tax cuts into this discussion? Again, I’m not trying to be snarky, I’m just trying to unpack the rhetorical strategy of citing the tax cuts of Reagan or Kennedy (Geoff in comment #4) vs. the tax cuts of Bush (Krugman, in every column for the last four months.)

  18. February 13, 2009 at 5:59 pm

    David, I think I fixed it, try it now. As for the banking things, I haven’t looked at it so I couldn’t say. I have become increasingly jaded, though, about these government rescue attempts’ divergence between what they say they’ll do and what they actually do with the money.

    “In other words, how much value has been sucked out of the economy because of mortgages not paid vs. investments/insurance policies/etc. based on those mortgages?”

    That’s an interesting question but I don’t know the answer.

    As for the Bush tax cuts, I don’t know if they helped or hurt the long term economic situation. But when Kennedy cut taxes the highest marginal tax rate was over 90%. So it would be perfectly plausible to be in favor of one and not the other from an efficiency standpoint. That said, the marginal tax on money earned now to be saved and given to my children after I retire or die is still probably in the 90% range.

    Also, it is worth bearing in mind what has been noted above by LL, there are both short and long run reasons for a given fiscal policy, and the answers may be different based on whether you want short term recession stimulus or long term efficiency and growth.

  19. Mike McBride
    February 13, 2009 at 6:43 pm

    Mark D. (#11): “I might add that I find it amazing that any educated economist can invoke Keynesian arguments with a straight face after a generation of such policies led to ruinous conditions Keynesians said were impossible in the late 1970s.”

    Here’s the rub. That earlier Keynesians had a Keynesian macroeconomic model that was incorrect does not mean that everything about Keynesian is wrong. The very macroeconometric models used to forecast by the Fed and others are still, as I understand, basically (Keynesian) IS-LM models with various rational expectations bells and whistles. That’s why you can get smart people to still use Keynesian logic about aggregate demand, aggregate supply, and slowly adjusting prices.

    Frank (#14): Well said. I wonder if Mankiw (who publicly confesses to being a Keynesian, I might add–or at least a New Keynesian if that distinction matters) read your post. Did you see his? http://gregmankiw.blogspot.com/2009/02/uncertainty-and-mpc.html

  20. MikeInWeHo
    February 13, 2009 at 7:15 pm

    This is great stuff, thanks. In comment #4 Geoff mentions “inevitable inflation” in the next year or two, but some appear worried that we might be headed into a deflationary spiral instead. Can somebody in here explain what that is, how it might happen, what it would mean, etc?

  21. Timer
    February 13, 2009 at 7:17 pm


    Isn’t the whole point the relative effectiveness? In your story, paying Harry a dollar for a service increases GDP by 1+x and giving Harry a dollar tax cut increases GDP by x. The ratio is large when x is small.

  22. Mike McBride
    February 13, 2009 at 7:37 pm

    MikeInWeHo (20): I can’t speak for (4), but textbook undergraduate Keynesian macro says that a short-run stimulus will eventually lead in the medium term lead to higher inflation. An overly simplistic way of thinking about is that if everyone were suddenly given and then spent some extra money, then this would drive up demand for goods and services and eventually be followed by price increases.

    I think many would say that this negative effect is outweighed by the positive effects of the stimulus, should they actually occur. They would say, “Do you want a severe depression and it entails or some inflation in a few years?”

    I haven’t seen any predictions of high inflation in the next year or so. Actually, inflation has slowed done a bit (what we call disinflation; it’s still inflation, just lower inflation), which is why some people have mentioned the spectre of deflation (which is negative price level growth). But the numbers don’t indicate that we’ll have deflation. If I remember correctly, the decline in inflation has tapered off.

  23. Mike McBride
    February 13, 2009 at 7:40 pm

    Hey Frank, I just noticed that you’ve got economics categorized under liberal arts instead of science on the blog. Trying to say something here?

  24. Steve
    February 13, 2009 at 10:21 pm

    Is anyone else worried about the possible effects of an additional deficit expenditure in the amount of $800 billion, in the middle of a credit crisis? When the government runs a deficit, it doesn’t just write IOU’s to the recipients of its expenditures (I’m pretty sure my mailman would quit his job). These funds are borrowed in international credit markets, which, while huge, are not infinite. A sudden increase in the U.S. federal budget deficit in such an immense amount has got to suck up a huge chunk of global available credit–especially given the current credit crisis. This should theoretically drive up interest rates (prompting greater savings, less consumption, and less investment), but since the Fed adjusts the money supply to meet a given interest rate, it can be expected to just crank out the greenbacks until inflation hits double digits again. Hey, at least I won’t have to worry too much about my student loans!

  25. aloysiusmiller
    February 13, 2009 at 11:30 pm

    He promised me ice cream who else would I have voted for?

  26. Mark D.
    February 14, 2009 at 12:26 am

    Frank M. (#14), Sorry, I wasn’t referring to you, but rather to the puzzling resurgence of Keynesian economics and economists in general.

    Mike M. (#21), The fact that the Fed still uses Keynesian models doesn’t mean they actually work very well. Given the Fed’s relatively recent track record, such usage does not inspire much confidence.

    I am old enough to remember the double digit inflation of the seventies, which I understand was largely the result of a couple of decades of Keynesian economic policy. The end was worse than the beginning. So when I see what Congress is doing, I think that we are highly likely to have a similar experience a few years down the road, if not something far worse.

  27. Jeremiah J.
    February 14, 2009 at 1:45 am

    Several smart and informative things have been said here, but the thread goes well beyond the post, and I think that the final two paragraphs of the post go well beyond the argument of the post. Frank, it’s true that some people favor spending stimulus rather than tax cut stimulus. But Daniel Gross is not an economist, nor the rhetorical head of a big school of spending stimulators, and the Obama stimulus package has tax cuts as well as spending in it. And there’s the standard well-worn pro-spending argument that says spending can be more easily directed to non-taxpayer or unemployed hand-to-mouth folks who will spend it (rather than richer folks who won’t spend as much of a tax break) that you don’t address.

    I’m not sure what “Congress keeps at”–spending rather than cutting taxes as stimulus? It seems they have done both and are doing both, and that both are pretty good (meaning bad, I guess) politics. Or are you saying that “fiscal stimulus” in general (from *both* tax and spending sides) is a bad idea? I don’t see your argument for that claim, and I don’t agree that we’ve known for a long time that stimulus never works. But maybe that’s not what you’re claiming.

  28. Alison Moore Smith
    February 14, 2009 at 3:54 am

    Thank you for the point in paragraph 4. Been banging my head on the dashboard over that issue during drive time radio.

    That said, chatting about the “stimulus” is absurd. No one knows what’s in it. Pelosi made sure of that. (Yes, the STD package went back in.) it’s unconscionable to vote in favor of measures that you haven’t so much as scanned.

  29. aloysiusmiller
    February 14, 2009 at 8:09 am

    Tax cuts do help people in the lower brackets. When the rich are spending and investing the poor go back to work. When the rich hunker down the poor starve. In 1990 the US enacted a luxury tax on yachts. The yacht building industry in the US shut down. No more jobs for poor yacht yard workers. But still plenty of yachts made and sailed overseas or in the Caribbean for the rich.

    If anyone thinks that Dem economists and politicians don’t know this then think again. They know it very well. They want the poor to be dependent on them not the economy. This stimulus is an impoverishment measure for control.

  30. February 14, 2009 at 9:47 am

    Mike, I am renouncing Science in favor of talking about My Feelings. I thought it was obvious…

    Jeremiah J. and Timer,

    The argument for why spending increases are a better fiscal stimulus is intimately connected to the argument for whether fiscal stimulus is a good idea at all. To the extent that tax cuts are alot worse than spending cuts, any fiscal stimulus is not generally going to have a lot of punch due to a diminished multiplier.

    Tax stimulus is a/(1-a). Spending stimulus is b/(1-a), where a is the marginal propensity to consume and b is the relative value of fiscal stimulus projects, discounting for the inherent waste and the distortions from increased taxation, etc. Keynes didn’t account for b — he set it to 1. If you think public spending is better than private, you could set b>1, or if not you could set it less than 1. a is clearly less than 1.

    Gross’ argument is that a in the numerator of the tax equation is so low that obviously we need spending stimulus over tax stimulus. He is ignoring, in the article, anyway, the fact that a is in the denominator of both equations. Thus a low a calls into question the whole enterprise. Of course, as Jeremiah noted, some of the stimulus is for things like unemployment benefits and other tax cuts that really do go straight to people. There are at least reasonable arguments for unemployment insurance, though I am not sure it needs to be publicly run.

    And yes, to Jeremiah specifically, I happily concede that my 500 word post is certainly _not_ a complete discussion of why fiscal (tax or spending) stimulus is, in general, not a highly prized idea among many economists. Rather, I was just pointing out that just because the situation is bad does not make a highly controversial idea like fiscal stimulus any better. Because the things that make the situation bad are not obviously corrected by fiscal stimulus.

    As for the “Congress keeps at it because it’s good politics”, I think you would find that Congress starts talking fiscal stimulus every time there is a downturn. In fact, looking at the deficit record, it might appear to a skeptical person that Congress looks at the equivalent of fiscal stimulus about every time they walk in the door…

  31. dh
    February 14, 2009 at 10:24 am

    I wasn’t being snarky either, but I fear a lack of response means either it was thought so or my question was too dumb to answer. I sometimes think a little bit of economics knowledge is a dangerous thing, but I don’t claim to having even a little bit.

    But since these policies are ultimately voted on by non-economists who represent millions of other non-economists, I think that sometimes those who know econ need to ry to boil it down for the rest of us to understand (if that’s possible).

  32. February 14, 2009 at 11:10 am


    “Call me crazy, but part of me is more worried about eventual inflation than the current recession.”

    I think Mike spoke about this inflation issue above. I am not worried so much about people going into more debt, but there is some concern, and always has been, the public debt crowds out private investment to some extent. So I think it is perfectly reasonable to think that we should be holding less debt, although there is good reason to think that the optimal amoujnt of U.S. debt isn’t 0. The existence of a liquid T-bill debt market is a pretty nice thing.

    Another concern is that, at some point, creditors begin to fear we might default on some or all of our debt (or inflate our currency which amounts to the same).

  33. Adam Greenwood
    February 14, 2009 at 11:58 am

    Frank M.,
    I keep seeing reports that investors are pegging the risk of US default at 6%. Do you have any idea where this number comes from?

  34. February 14, 2009 at 1:20 pm

    Offhand, no, although somebody else might. If you have a riskless asset you can look at the difference between the interest rate on that asset and the T-bill to get a guess at a risk of default. But, um, the T-bill was what people usually used for the riskless asset…

    I would be amazed if there was a 6% chance the U.S. defaulted on its national debt. But it might inflate the currency more than normal so the long term debt is worth 6% less…

  35. February 14, 2009 at 3:44 pm

    I find it revealing that when Frank talks about his feelings he is still talking about economics.

  36. Mark D.
    February 14, 2009 at 4:16 pm

    Adam G., I think in practice the Treasury is far more likely to print money if necessary to service the national debt than default. Most countries do not have that privilege, because most of their debt is denominated in some other currency, often ours.

    However, to the degree that such a thing makes sense, you can buy credit default swaps for 10 year U.S. treasury bonds for about 40 basis points, implying an estimated default risk within ten years of 0.4%. Of course collecting on such CDS in the event of a U.S. default might be easier said than done.

    Generally speaking, that is not going to happen as long as the U.S. is not forced to borrow in terms of other currencies. I understand in Iceland it was very common for people to have mortgages denominated in foreign currencies, and after the recent crisis, the outstanding balance in terms of the local currency more than tripled.

    In our case if the Treasury inflates to service the national debt, the most direct consequence is imports get more expensive, potentially much more expensive. The secondary consequence is that market interest rates, especially long term rates, increase dramatically. The Chinese aren’t going to want to lend money to us any more if they believe we are going to pay them back with depreciated dollar bills. Worst case you get a hyperinflationary blowoff and the U.S. currency becomes worthless a la Weimar Germany.

    It seems probable, however, that a gradual process of inflationary impoverishment is much more likely. 7% inflation over ten years is enough to reduce the real value of the national debt (and all dollar denominated savings) by half. The seventies were worse than that. It is the ultimate transfer program…

  37. woodboy
    February 15, 2009 at 1:42 am

    “In our case if the Treasury inflates to service the national debt, the most direct consequence is imports get more expensive, potentially much more expensive.”

    Unless all of our trading partners are simultaneously devaluing their own currencies. Mark’s right, the US is not going to default. Our debt is the safest there is.

    And #22, how do you figure the numbers don’t indicate deflation? The economy’s been in deflation/deleveraging mode for quite some time, and will continue to be.

  38. Mark D.
    February 15, 2009 at 3:42 am

    In the event of a world wide sovereign debt crisis, if all governments inflate more or less simultaneously, it is true imports may not rise in cost relative to domestic products. The trade balance may remain be about the same. Everyone’s savings will just be blown away.

    As long as the governments of the world run budgetary deficits, the “prudent” course is to depreciate everyone’s savings piecemeal. That is what “backed by the full faith and credit of the U.S. government” means in this case – it means that all holders of dollar denominated assets will share the pain equally, rather than just the holders of Treasury bills.

  39. February 15, 2009 at 10:58 am

    I wish this were not such a partisan and class issue which makes the approaches less effective than they would be.

    will temporarily stave off the ultimate correction and make the eventual market correction harder to bear.

    I used to be an econ type (my GRE in econ was 800), but there isn’t much to criticize, other than to note that the drag from the debt incurred is estimated to make the stimulus package effect negative within ten years.

    I’d feel better if sometimes the Republicans didn’t act like a drunken uncle who was spending the rent money and the Democrats like a crazy aunt trying to feed wild cats.

    Should be interesting to see what happens. My post at http://ethesis.blogspot.com/2009/02/resilience-then-comments-on-life-from.html was directly related to the coming times.

  40. Mark D.
    February 15, 2009 at 3:53 pm

    I’d feel better if sometimes the Republicans didn’t act like a drunken uncle who was spending the rent money and the Democrats like a crazy aunt trying to feed wild cats.

    Don’t you have that backwards, relatively speaking?

  41. Timer
    February 15, 2009 at 4:58 pm

    Frank (#30),

    Yes, this is what I had in mind (with x=a/(1-a) and
    b=1). Two ways to respond to your observation:

    1. Stimulus will not be as effective as at other times given current small a, so let’s not have a big package now.

    2. Due to small a, we need a really _big_ package (and really heavily tilted toward spending and/or transfer to individuals with high propensity to consume) to prevent the economy from operating at trillions below full capacity for years.

    The former seems to be your view. The latter is the view of Paul Krugman at NYT and many others on the left. But the current Republican approach of trying to make the package big and mainly about tax cuts seems to be the worst of both worlds–expensive and maximally ineffective. Do you agree with that?

  42. John Buffington
    February 16, 2009 at 4:14 pm

    Reminds me of the two snakes who would not leave the Ark to go forth and muliply, since they were adders. Upon inquiring of the Lord, Noah decided to use logarithms on them…

  43. February 16, 2009 at 4:47 pm

    Timer, personally I lean towards your #1.

    The Congressional Republican position is perhaps as plausible as #2, depending on the values one assigns to a and b. I am, perhaps, overly sensitive to corruption, given its importance in stunting the developing world. To me, b reeks of corruption opportunities.

  44. Mark D.
    February 16, 2009 at 6:46 pm

    Frank M. / Timer,

    How is anyone supposed to take seriously a formula that has an infinite singularity at x = 1? As if we could have an infinite GDP overnight by simply spending all of our income.

    Shouldn’t the simplest of such estimates have terms for the unemployment rate and the size of stimulus relative to GDP?

    It is the use of formulas like this that give the appearance that Keynesians don’t have a firm grip on economic reality.

  45. Mark D.
    February 16, 2009 at 6:47 pm

    That should be a = 1, where a is the marginal propensity to consume.

  46. Kevin
    February 16, 2009 at 11:48 pm

    Whether or not this will “stimulate” our economy is really an irrelavent point. Take an hour or two of your day and learn what is really going on.


  47. February 17, 2009 at 11:31 am


    Yeah, I’m not a Keynesian either. I’m sure such a person would offer all sorts of answers to your point, but I’m not going to bother :).

  48. February 17, 2009 at 12:15 pm

    MikeinWeHo (#20), sorry to take so long to respond. Take a look at this article:


    With the stimulus package and TARP, we are heading toward extremely high deficit spending as a percentage of GDP (and in absolute terms). The issue is, where does the govt get the money to pay for all the banks and car companies that are being “saved”, pay unemployment insurance and pay for all the pork? Well, the government has to borrow it from somewhere. Interestingly, lately, much of the borrowing has been from China and Japan, which have been buying T-bills with their hard cash (cash we send them from all the stuff they make). See this article, with interesting information on the increase in foreign ownership of our debt from about 13 percent to 25 percent.


    So, what worries me about inflation is, what happens with Japan and China can no longer buy our debt? It would seem that we are left with printing money, and this inevitably leads to higher inflation. So, short-term, deflation is still a concern but long-term (2-3 year) inflation seems a big worry. Frank, please correct me if my analysis is too simplistic.

  49. Rameumptom
    February 17, 2009 at 12:37 pm

    Good post. Neither tax cuts nor spending can necessarily fix the economy. Bush tried tax cuts and giving everyone several hundred bucks last year, and it didn’t do anything, for instance.

    Spending is only useful if it is spent wisely, in areas that create real jobs. $300 million for STD courses, and $80 million for schools in Milwaukee (which is closing schools due to lack of kids), will not create new, long term wealth.

    Wealth comes when we can create and sell things people want. We no longer manufacture much here, and most of what we create is now being out-sourced offshore. Idiots on Wall Street insist that we can just keep ahead of everyone else by getting eternally smarter jobs – ignoring the fact that 50% of the American people are below average intelligence.

    What happened to spending that trillion dollars on energy and rebuilding our infrastructure? Kind of missed the boat on this one, so we really will be getting a series of stimulus packages coming our way. First was a stimulus package for the banks. Now a stimulus package to satisfy Nancy Pelosi’s constituencies. Later will be stimulus packages for energy, infrastructure, etc. And no one is yet dealing with the housing crisis. We will, in essence, spend several trillion MORE dollars, because Congress wasn’t serious about it the first few times around.

    Bloomberg news mentioned a few days ago that this spending by Congress and the Fed is now approaching $9 trillion. This is enough to pay off 90% of the mortgages in the USA. Wouldn’t it have been cheaper to offer to pay off 1/3-1/2 of everyone’s mortgages ($3-5 trillion)? It would keep people in their homes. Not only those who made stupid choices would benefit, but all homeowners would benefit. Banks would instantly be flush with cash, due to the large portion of mortgages being paid off. And since people would stay in their homes, with smaller mortgages, they would continue to pay the remaining loans to the banks over several years. This would also free up money for business loans, and for individuals to buy cars, etc.

    We do need to start rebuilding America. We can’t help the rest of the world, if we collapse, as did the Soviet Union in 1990-1. Energy is a good place to start. All of the empty auto factories in the Great Lakes region could be converted over to building wind mills, solar panels, and other potential energy technologies. Our taxes could give seed money for the next 5 years, and then get repaid through profits thereafter.

  50. woodboy
    February 17, 2009 at 1:26 pm

    “It would seem that we are left with printing money, and this inevitably leads to higher inflation”

    Generally speaking, this is true. But whether or not new reserves make it into the system to inflate the money supply depends on a lot of factors such as the velocity of money, the amount of new credit/debt creation by banks, etc. Right now the value of private sector debt is collapsing (when properly marked) faster than government debt is increasing, and new credit is not being created as it once was. All of this represents an intense deflationary force. If there is any doubt as to how long or how pervasive deflation can be, look at Japan. As long as banks are deleveraging and debt is being written down, inflation will not take hold.

    China will keep buying our sovereign debt as long as they are running significant trade surpluses (which are now bigger than ever). The real question in my mind is whether the rest of the bond market will be able to absorb the supply the Treasury will have to create to fund the increased spending, and on this front it seems likely the government’s borrowing costs will rise significantly from their current low rates.

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