Sep 29 2009
How big is the government spending multiplier in America? Well, it depends on which economist you ask…
Published by Jason Welker at 4:59 am under Consumption,Crowding-out Effect,Fiscal Policy,Government,Interest rates,Investment,Keynesian Economics,Macroeconomics,Multiplier effect,Recession,Savings,Unemployment
Economics focus: Much ado about multipliers | The Economist
What is the goal of fiscal stimulus during a recession? Is it simply to increase nation’s total income by a certain amount determined by how much a government increases its own spending by? If this were the case, then an $800 billion stimulus package, like the one begun this year in the US, would lead to a total increase in national income of, well, exactly $800 billion.
While such an outcome is possible, it is not the desired outcome of the Obama administration and the economists who have supported the use of expansionary fiscal policy during economic downturns (i.e. the Keynesian school of economists). Keynesians expect that an initial increase in government spending (or a decrease in taxes) will result in households and firms increasing their own consumption and investment, meaning successive increases in spending. The initial change in spending ultimately gets multiplied through further rounds of spending. The total change in national income resulting from an initial change in government spending or taxes depends on the size of the fiscal multiplier. Now, this is where things get tricky! From the Economist:
The size of the multiplier is bound to vary according to economic conditions. For an economy operating at full capacity, the fiscal multiplier should be zero. Since there are no spare resources, any increase in government demand would just replace spending elsewhere. But in a recession, when workers and factories lie idle, a fiscal boost can increase overall demand. And if the initial stimulus triggers a cascade of expenditure among consumers and businesses, the multiplier can be well above one.
The above scenario, where an economy is operating below full-employment and government spending puts the nation’s idle resources to work, creates new income and further increases private spending, is precisely what the Obama team and its economists hope will happen in the US economy soon. A multiplier of above one means the $800 billion will ultimately increase America’s national income by something greater than $800 billion!
The multiplier is also likely to vary according to the type of fiscal action. Government spending on building a bridge may have a bigger multiplier than a tax cut if consumers save a portion of their tax windfall. A tax cut targeted at poorer people may have a bigger impact on spending than one for the affluent, since poorer folk tend to spend a higher share of their income.
Crucially, the overall size of the fiscal multiplier also depends on how people react to higher government borrowing. If the government’s actions bolster confidence and revive animal spirits, the multiplier could rise as demand goes up and private investment is “crowded in”. But if interest rates climb in response to government borrowing then some private investment that would otherwise have occurred could get “crowded out”. And if consumers expect higher future taxes in order to finance new government borrowing, they could spend less today. All that would reduce the fiscal multiplier, potentially to below zero.
Herein lies the controversy about the effectiveness of deficit-financed fiscal stimulus. Several posts on this blog have focused on the neo-classical, supply-side economists’ fears that expansionary fiscal policy financed by government borrowing will drive up interest rates to private borrowers, thereby “crowding-out” private investment, off-setting any expansion in output achieved through government spending. In the Keynesian model, however, it is precisely because interest rates have bottomed out at the “zero bound” (according to Paul Krugman) that government borrowing and spending will not lead to crowding-out, rather could actually increase investors’ willingness to spend (their “animal spirits”) on new capital, actually “crowding-in” private investment.
Alas, the debate continues. The ironic thing is that even years from now, after all of Obama’s stimulus money has been spent, and the US economy is either fully recovered or it is not, we still won’t know how large the fiscal multiplier was, since tomorrow’s economists will find it nearly impossible to isolate the variable of the $800 billion of government spending and determine just how much of America’s growth in income can be attributed to government spending, and how much resulted from automatic stabilizers built-in to help the economy recover on its own during recessions.
Discussion Questions:
- Why do tax cuts for the rich tend to have a smaller multiplier effect than tax cuts for lower income households?
- How can government borrowing drive up interest rates, and why is this a concern to policy makers deciding on the size of a fiscal stimulus package?
- What are the animal spirits the article mentions? Where have you heard this expression before?
- Do you think borrowing trillions of dollars and spending it to put people back to work and try to dig the US economy out of recession is wise, or should the US government be practicing better fiscal responsibility?
About the author: Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course.
Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this authorRelated posts:
- The potency of government spending and taxation.
- A must read for AP Macro teachers: Paul Krugman explains why deficit spending during a recession does NOT cause crowding-out
- The Multiplier Effect as it applies to the Obama camp’s fiscal stimulus proposal
- Too much debt or not enough demand? A summary of the debate over America’s fiscal future
- Will the stimulus package “crowd-out” private investment and reduce long-run growth potential in America?
In low income families, taxes weigh heavily. If we reduce taxes, more members of the families are likley to look for work, as they will have more money left over after tax, and will therefore be more willing (and able) to spend. This higher spending leads to more government revenues from VAT. Those who have a high income have the luxury to save some of their money, and are thus less likley to have a large effect on the multiplyer…
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Tax cuts for the rich tend to have a smaller multiplier because the rich do not spend as much of their income. but, for the poor since they spend more of their income it significantly changes the amount that they can buy.
government borrowing drive up interest rates because if the government needs to borrow money then they usually borrow a lot of money, therefore they increase the amount demanded and the rates go up.
I think that borrowing trillions of dollars and spending it will put people back to work, since it seems like what an entrepreneur has to do. an entrepreneur borrows money to start a business then makes enough money to pay back the loan. just now the government is doing it and people will be paying back by taxes.
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1. Tax cuts for low income households will have a greater effect on the multiplier because these households spend most of their DI. This is because they cannot afford to save their money and if they see a cut in taxes they are more likely to consume more due to their higher DI. The richer households on the other hand have (as Bjorn mentioned) the luxury to place some of their income into saving accounts and would therefore not differ much in their consumption habits if they had an increase in their DI.
2. If the government borrows too much then interest rates will be pushed up because the government will have lost a lot of money in it's borrowing of money and will drive up interest rates in order to gain some money back; this could then lead to a "crowding out" in public investment. And this is a concern to policy makers because the bigger the fiscal stimulus package the higher the interest rates will be and the lower public investment will be leading to no output increase.
3. The animal spirits referred to in this article is in sorts the bare instincts or faith of the people to their government. For example, the Keynesian believe that lower interest rates could revive the faith of the people and drive them to help their government and invest more into new capital. This term was also mentioned in the rap video we watched in class about the Keynesian vs. Classical views on macroeconomics.
4. I think it's a good idea because government spending has a solid theory which supports that AD should increase and even multiply after a stimulus package is poured into the economy. Also I think it's a better idea than the classical point of view that the government should not do anything because the economy will fix itself…but that could take a while and I feel obliged to quote Keynes's motto "In the long-run we're all dead". Although the economy could self-correct eventually there are too many unemployed people for the government to just sit on its hands and do nothing. If an increase in G leads to an increase in AD in addition to an increase in I + C depending on the multiplier, and with AD shifting out the economy should gradually move towards an equilibrium PL with the NRU or Yfe then why not do it? In my mind there is no doubt that Obama and his team did the right thing.
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Tax cuts would have a greater effect for low income households because they must spend more of their money on taxes, therefore increasing the multiplier to a greater extent than the richer households. The rich, on the other hand, must pay a greater percentage of taxes, yet they make more money, so they also have some money to save or spend elsewhere. Therefore, they have less of an impact on the multiplier than the poorer households. I think the stimulus package is a good idea overall because it will increase AD in the short run, which will hopefully lead to an increased AD in the long run too. With stability in the short run, maybe the long run can profit from this.
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In families with lower disposable incomes taxes severely affect their decision making on what they need and want. So when their DI increases they can spend the money on what they want and what their need rather than solely paying for their needs. Where as families with higher DI's already have enough money to full fill their wants and needs with out the need to worry about the tax.
When the Government spends too much then interest rates will raise so that G can get some money back.
Animal spirits, is the fact that human's are not perfect therefore why nothing in economics can be definitely calculated to the specific person. Because nobody is exactly the same. And I heard this is class yesterday.
I think this is good because if I remember this is called a stimulus package The whole goal of the stimulus package is to supply AD with a kick which would then restore company's revenue. This is done with the idea that it remains like that so company's start re-employing workers.
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1. Why do tax cuts for the rich tend to have a smaller multiplier effect than tax cuts for lower income households?
Lower income people spend a higher percentage of their income than the wealthy, who tend to save more.
2. How can government borrowing drive up interest rates, and why is this a concern to policy makers deciding on the size of a fiscal stimulus package?
Governments sell bonds to finance deficit spending. This increase in supply of bonds drives down their price, thus increasing the interest earned on each bond. To compete with the higher return offered by government bonds, private banks must raise interest rates. These higher interest rates decrease the level of investment, a potentially dangerous consequence.
3. What are the animal spirits the article mentions? Where have you heard this expression before?
We heard this term in the Keynes vs. Hayek rap video, where Keynes referenced animal spirits. They are the confidence or lack thereof that consumers and investors have. Higher confidence leads to higher investment and consumption, while the opposite is true for lack of confidence.
4. Do you think borrowing trillions of dollars and spending it to put people back to work and try to dig the US economy out of recession is wise, or should the US government be practicing better fiscal responsibility?
I believe it is a good idea, because it is the most effective way of driving up demand and restoring confidence. However, repeated and long-term borrowing can bankrupt a government, so restraint is needed to a certain degree.
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[...] How big is the government spending multiplier in America? Well, it depends on which economist you as… [...]
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1. Why do tax cuts for the rich tend to have a smaller multiplier effect than tax cuts for lower income households?
• The rich tend to make up a much smaller proportion of a national economy, and the average-income households make up the majority of an economy. Therefore, MPC will increase only slightly, because avg. income households will save more money than consume. The rich will consume more, but since they make up a usually very small proportion of an economy, as mentioned, the MPC will increase only slightly, compared to the majority of the population.
2. How can government borrowing drive up interest rates, and why is this a concern to policy makers deciding on the size of a fiscal stimulus package?
• The government is competing against the private sector for money, thus driving up interest rates on the money, because it is limited in amount. The reason this concerns policy-makers is because the higher the interest rates, the more money they will have to pay back when they must re-pay the money they borrowed.
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3. What are the animal spirits the article mentions? Where have you heard this expression before?
• "Animal Spirits" in this article (and generally) refers to consumer confidence. We have heard this expression in a prior assignment when studying Keynes' beliefs.
4. Do you think borrowing trillions of dollars and spending it to put people back to work and try to dig the US economy out of recession is wise, or should the US government be practicing better fiscal responsibility?
That depends. Drawing on Keynes' beliefs, expansionary fiscal policy is very often beneficial in stimulating an economy in times of recession; it creates new jobs, puts those unemployed back in jobs/positions, and returns a nation's AD back to regular levels. However, from what we have seen over the last few years in the United States, we can very evidently see that more sophisticated and more appropriate fiscal responsibility and policy is necessary and urgently called for. The next elections, coming up in 2012, will hopefully give us the opportunity to correct the flagrant, misguided, liberal, economic policies followed by the current US Presidential Administration.
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I don’t know anyone who is aflifiated in aflifiated marketing. So I can’t really answer that. but I do know, that you wouldn’t be owning your own business unless you invest money into it. By means of a start up cost, or buying products yourself and re selling them, advertisement or something along those lines. Owning a business is not free. I wrote some things down that might help you to see for yourself if this is a good business to get involved in, using my business as an example. If on the list it checks out (you may have to do some research) but if it all checks out, then you can chose to do it. IF it’s a business, don’t just try it. You need to devote time and effort into it and build it. If your going to just try a business, you will most likely fail! So here’s a few things that you should take a look at before getting involved in any company.1. How long have they been in business? We checked to see how long our company was around, at the time it was nine years old and now it’s 15. Do you know when they started? If it’s under 5 years, then their is a risk factor2. Are they registered with the BBB. Ours is registered. I think this is important one.3. Who’s involved with the company? Like in ours Donald Trump, Robert Kiyosaki has endorsed our company. Many actors and actresses, business owners, government officials etc use our products. Check to see if anyone has endorsed this company. Also, meet with the co-founders. We’ve personally met our co-founders and found from our first meeting that they were incredible people with incredible visions. See if their’s a time where you can meet them. If your going to be doing business, there should be a time where you should have the chance to meet with them.4. What is the compensation plan now, and what was it like before.See the history of the comp plan and see if increases and never decreases in it’s history. We checked with the records in our business and found that in over the years, the compensation plan had only gotten better each year. As long as we’ve been involved, we’ve now witnessed the compensation plan always increasing. Check the history on yours.5.Have they been featured in magazine’s? For instance our company has been featured in several magazines Like Success, Fortune, USA Today etc. Check to see if they have. You can get a lot of information on the company by reading about them.6. Has Inc 500 rated them? This magazine or slit rated our company the 22nd fastest growing company in revenue in it’s first 5 years. Inc 500 shows the top 500 businesses in revenue growth. Check to see what Inc 500 rated the company your looking at.7. Do they have a physical address that you can go to? Check for an address not just a P.O. Box8. Where are their headquarters? Our world headquarters is in Farmington Hills Michigan, Personally been there, (If your here in the states) Other headquarters in different countries. and US headquarters in Charlotte.9. What does the start up cost take care of? If there is no start up cost, what will you have to be dishing out and for what? In my business headquarters takes care of all the billing for my customers, Inventory, Customer services, Order Entry, Employees, workman’s comp, Cross referencing, Licensing, Insurance, paperwork, accounts payables, accounts receivables etc.10. What is the product and service you would be selling.Is the product and service in high demand? For instance we offer services that people are already using every day and paying for anyway, but at a lower cost. Things like Local and Long distance telephone services, Internet, video phones, digital phones, cellular phones through all the major cellular providers. We make a percentage every single month they pay their bills. Everyone uses them and everyone pays for them. When money gets tight, would they keep your service or be able to run to the store and be able to purchase them on sale? Leaving you to have to wait until they run out of what they just purchased, or wait until their finances get settled? This is what I mean by high demand.So many different things to check out in making sure a business is a good one to get involved in. If the business feels right to you, and all questions are answered and you feel good about it, then I’d say jump in. Running a business is different then a job though. You have to treat it like it’s your child and not just something your going to try you have to believe in the product and service and go at it full force. This is your future your talking about, no one else’s.I hope my examples of what we looking into with our business helps you be able to find the same answers in the business your looking into. Forget about asking the common question and asking someone how much they make in their business to determine if you’d get involved in this or not. In a business, it doesn’t matter what one business is making over another. It only matters what you do in YOUR business. I hate it when people ask me how much I make. Because they’re not going to walk into and start up their business making what I make. I’ve been involved with my business for over six years. So yeah, I will make more. If you tell someone how much you make, then it’s a psychological thing that they expect to make that amount in a week, and that is just not going to happen. Six years of building a business verses 1 day. So don’t even ask. Look at the possibilities for YOURSELF. If you have any further questions or need help,feel free to contact me at
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