Wednesday, July 15, 2009

Two handed economist - multiplier debates

The debate about the utility of various fiscal policy measures in combating economic recessions has revolved around the magnitude of the respective fiscal multipliers. These fiscal multipliers, which measures the impact of an increase in government spending on GDP and employment, are critical for determining the appropriate size and timing of countercyclical fiscal policy packages. In evaluating the recent $787 bn US fiscal stimulus, Christina Romer and Jared Bernstein had estimated the fiscal multiplier at 1.6.

Greg Mankiw points to two studies that sought to calculate the fiscal policy multipliers in a new Keynesian DSGE model when the economy is at the zero interest lower bound. On the one hand, Martin Eichenbaum, Lawrence Christiano, and Sergio Rebelo find large multipliers, while on the other hand, John Cogan, Tobias Cwik, John Taylor, and Volker Wieland arrive at far lower multipliers!

The first study finds that the government spending multiplier can be very large when the zero bound on nominal interest rates is binding. In contrast, the latter claim that the multipliers are less than one as investments and consumption gets crowded out. Brad De Long draws distinction between multipliers on spending during normal times and when the rates are touching the zero-bound. He argues that the Cogan-Cwik-Taylor-Wieland model is a model of a small multiplier in an economy away from the zero nominal interest rate bound when central banks are targeting inflation.

Update 1
Paul Krugman responds here and here.

1 comment:

Anonymous said...

1. What is the multiplier effect of spending in the Indian stimulus package?
2. Has anybody estimated the same? Can the study be used to guide targetting? Why is policy not guided by informed thought?
3. Has the state of AP made any such thought?