Magic multipliers

We've heard a lot about the multiplier effect, the extent to which whatever stimulus we come up with will magnify and synergize and spread through the economy. These numbers are becoming entrenched in the rush to spend government money, and any kind of pushback is jumped on as suspect.

And that's good, because there's a lot of nonsense going around. Kevin Drum has just written a post about Robert Barro, writing in the Wall Street Journal, who claims that the multiplier is less than 1.0 (that is, that government spending has a dampening effect on GDP)...and uses the example of World War II as his proof.

As Drum correctly points out, this is nonsense masquerading as analysis. Since the stimulus is supposed to raise employment to get spending going, and pretty much everyone was employed during the war, the current situation cannot be compared to what was going on in the '40s.

That doesn't mean there aren't problems with the models, however. As I wrote in a comment on Drum's piece:

Yes, it's true we can't compare the current situation to WWII, and any analysis that does is horribly flawed.

By the same token, it's hard to compare any past situation to now, as conditions are quite different than they have been before (it's false to assume that the only dichotomy is wartime vs. peacetime).

Any multiplier calculation that depends on money running through employment has to take into account that the U.S. labor economy is no longer closed, that some part of the stimulus may well go to cranking up the Chinese factories and the Indian call centers. That may well end up positive for the U.S., in the very long run, but it is not as direct a link as it was before. That makes these magic multiplier formulas far less accurate, based as they are on very different conditions, than they might be otherwise, and should lead to some degree of caution in establishing policy.

Let's remember that economics models failed to predict the magnitude or timing of our current difficulties. I am not going to invalidate everything that comes out of economics as a result, but I do think all such conclusions need to be taken with a huge chunk of salt.

Today is not yesterday, and those who wish to assert that it is are going to be wrong.