Wednesday, February 18, 2009

Brad Delong (and I) on Robert Barro

Evidence, Logic, and Robert Barro

Hoisted from Comments: Richard Green writes:

Grasping Reality with Both Hands: Council on Foreign Relations Wingnut Watch: Benn Steil: I am glad that Barro's logic escaped you, as well. As I am not a macroeconomist, I figured that it was I who was dense. But it seemed to me that the facts presented in the article showed that even an enormous stimulus that burned a lot of resources (building tanks and ships that will be destroyed are kind of like bridges to nowhere, economically) had very little crowding out effect.

The context is Benn Steil's claim that Robert Barro's January 22, 2009 Wall Street Journal op-ed "provides logic and offers evidence" to support Steil's claim that the interest elasticity of money demand is zero and thus that the fiscal multiplier is zero too.

As I said before, the evidence that Barro presents suggests a multiplier for temporary government purchases not of Steil's zero but instead of 0.8:

Robert J. Barro: Government Spending Is No Free Lunch: Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II.... I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540).... We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War.... Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before...

But it is the logic that most puzzles me. Barro writes:

The [Keynesian] theory... assumes that the government is better than the private market at marshaling idle resources.... Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system. John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved -- but economists have not come up with explanations, such as incomplete information, for multipliers above one...

If I read this paragraph correctly, Barro thinks (a) there are theoretical reasons to think that the fiscal multiplier cannot be greater than one, and (b) there are theoretical reasons for thinking that if you believe in positive fiscal multipliers you should also believe that expansionary monetary policy that raises the flow of nominal spending will also raise employment and production--which people do, for it is only when they fear that monetary policy is tapped out and cannot raise the flow of nominal spending any more that they fear that monetary policy may be ineffective.

So I don't understand how Barro gets to his very next sentence:

A much more plausible starting point is a multiplier of zero...


Anonymous said...

Double counting. If the public sector borrows 1 trillion widgets from China, and gives them to citizens to motivate them to dig/refill ditches, this is counted as expanding GDP by 1 trillion widgets.

When the ditch diggers trade the widgets for 5000 cars, this is counted as a secondary follow on effect, expanding GDP by 5000 cars.

Total expansion is 1 trillion widgets plus 5000 cars. Magic.

In reality, GDP did not expand when the public sector borrowed 1 trillion widgets. The economy only expanded when 5000 cars were produced domestically.

There is still an accounting problem though, as now China wants to be repaid 1 trillion widgets. Unfortunately, citizens have already consumed the 5000 cars, and China has no use for refilled ditches located in the US.

This absurd accounting system is used to pretend multipliers have taken place.

Anonymous said...

In short, the BLS subtracts imports from GDP, but those calculating the multiplier effect conveniently forget to subtract the additional imports from additional G.

Back in days of yore, when domestic citizens stuffed cash in mattresses, public borrowing of the mattress cash really did expand GDP by the additional G. In modern times, citizens don't stuff appreciable quantities of cash in mattresses. Nowadays, citizens consume more than they produce. Additional public spending can only come from additional imports.

In this case, publicly borrowed imports are replacing privately borrowed imports. Foreign creditors have stopped loaning to the US private sector, so the public sector is borrowing imports instead. The imports are being used to pay public workers, allowing cuts in the payroll tax and such.

Anonymous said...

This is so true...
"Double counting. If the public sector borrows 1 trillion widgets from China, and gives them to citizens to motivate them to dig/refill ditches, this is counted as expanding GDP by 1 trillion widgets."

Anonymous said...

congratulations! this blog is very interesting and has information most important we invite you to visit our blog and and you will find both. Prices will amaze you Great investment opportunity at Costa Rica Pacific Coast, costarica real estate ,

retirement in costa rica, costa rica condominiums. Visit us for more info at:

Anonymous said...

If the public sector borrows 1 trillion widgets from China, and gives them to citizens to motivate them to dig/refill ditches, this is counted as expanding GDP by 1 trillion widgets.

Except we don't borrow "widgets", we borrow money, say $1 trillion. The government spends the money on public goods, thereby infusing the private sector with $1 trillion. That increases GDP by $1 trillion. But nevermind that. The private sector now has $1 trillion more to spend on private goods. Not all of it will be spent, of course, but some amount will, which will increase GDP by some further fraction of $1 trillion, let's say $400 billion (or whatever amount you like).

The "multiplier" would be 1.4--$1.4 increase in GDP for every $1 of government spending. You are right that the initial loan has to be repaid at some point, with interest. Let's say the total interest amounts to 20%--then we have to pay $1.2 on every $1 that we borrowed. That leaves us with 20 cents extra growth for every dollar we borrowed. Now, it is a fair question whether we could have gotten more or less growth had we not borrowed and spent, but it is not decidable without examining the evidence.

This absurd accounting system is used to pretend multipliers have taken place.

This absurd accounting system is also what allows your bank deposits to magically be in more than one place at once--to be both counted as an asset in your portfolio and be active as cash loaned to a private business. So if you don't believe in multipliers then clearly you don't believe in finance either.

Unknown said...

Congratulations!!!! excelent post. It has information most important. Please visit our blog

Anonymous said...

Congratulations! this information it is very interesting, I invite you to visit my site about Costa Rica Real Estate and Retirement in Costa Rica and you will find both. Prices will amaze you have a great investment opportunity to invest in Costa Rica Pacific Coast.
Visit us for more info at:

Anonymous said...

ohh...I think its nie information, if you looking Dubai Real Estate Property, you can go there.