By Request: Stimulus Size
Mickslam wants to know “The size of the stimulus necessary to get us out of the recession and avoid the depression.”
So do I! The answer is that it’s hard to say. Paul Krugman’s post on stimulus arithmetic illustrates the issues. But as a starting point, let’s pull out of the air the estimate that absent stimulus the unemployment rate will wind up at around 9 percent. That’s about 4 percent points over what we now think is the Non-Accelerating Inflation Rate of Unemployment (NAIRU).
Now we have to think about Okun’s Law which relates increases in GDP to decreases in unemployment. Since this isn’t a real law, people are a bit fuzzy on the math. But the consensus is that to generate a one percent decrease in unemployment, you need a 2–3 percent increase in GDP. That means $300-$450 billion per percentage point or $1.2–$1.8 trillion in additional GDP.
Next is the issue of the “multiplier effect” which relates how many dollars of additional GDP you get for each additional dollar of stimulus expenditure. These are the estimates all the cool kids are using:
The catch here is that when you’re dealing with giant numbers, these multiplier estimates are going to break down. Food stamps gives you great bang for your buck. But just because $1 billion in increased food stamp spending might generate $1.7 billion in GDP doesn’t mean we could spend $1 trillion in extra food stamps and generate $1.7 trillion in extra GDP—there are only so many poor people and they can only eat so much! Much the same is true with infrastructure spending. The general idea of spending-side stimulus is to put idle assets to work doing things. We have a fair number of idle people. But to build new infrastructure you machines and so forth and we only have so many on hand. And of course you need the right people—the guys who got laid off from Lehman Brothers aren’t the engineers we need to build the Purple Line.
And of course all this is based on slightly fuzzy math about the NAIRU and very fuzzy math about likely employment trajectories. Long story short, whatever topline estimate you could do would be pretty uncertain and would run into trouble when you started thinking about implementing it in a micro sense. To make a long story short, the correct answer is a big number but the real limits probably lie in thick in the weeds rather than up in the clouds in a way that makes calculations very difficult. And then on top of all that you need to consider the international situation—will our stimulus money “leak” out of the economy in the form of a trade deficit? Will giant stimulus make the currency much weaker and alter trade flows? How much stimulus will China offer? Germany? In principle, the big surplus countries—China, Japan, Germany, Switzerland, Norway, etc.—should be doing more lifting relative to the size of their economies than should the deficit countries. But I don’t think that’s how it’s going to work in practice.
20 Responses to “By Request: Stimulus Size”
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January 10th, 2009 at 1:32 pm
The most informative article I have seen on stimulus package. Where are the multiplier estimates from?
January 10th, 2009 at 1:45 pm
I think we should stimulate the economy by investing many billions of dollars in macroeconomic research until we figure out how to actually fix everything. Because, honestly, no one has any fucking clue right now — not Matt Yglesias, not Paul Krugman, not the ghosts of John Maynard Keynes and Milton Friedman, not Ben Bernancke, not Larry Summers, and not Barack Obama. Like blind men in an orgy, we’re going to have to feel our way out.
January 10th, 2009 at 2:32 pm
NAIRU is a totally arbitrary standard without any real scientific merit. I wish people would disabuse such sentiments.
January 10th, 2009 at 2:46 pm
Thanks for the Purple Line plug! But actually, the electricians who got laid off from building houses, and the structural steel erectors who won’t have work when their office building projects finish, are the guys who do have the skills to build the Purple Line.
For that matter, the skills you need to do a transit ridership model have lots of overlap with the skills a quant on Wall Street has. And I’m sure Wall Street is busy laying off the guys who actually figure out and write the models while protecting the jobs of the least productive.
January 10th, 2009 at 3:03 pm
I’m not too thrilled with the idea that people are taking NAIRU =5% as god-given, or the idea that NAIRU exists at all. After all, we’ve had unemployment in the 4% range without too much inflation in the past, and other nations have managed below 3% for extended periods of time.
I will say this about the discussions around Okun’s law – this is why I see a major difference between job creation programs like the WPA and Keynesian stimulus. Because you really don’t need 2-3% of GDP ($240-360 billion) to create two million jobs; you need that much to create that many jobs in the private sector through fiscal stimulus.
By contrast, if you just hired people at $24k/year, it only takes approximately $62 billion (assuming 30% non-labor costs, a figure I’ll explain if asked)- which is .5% of GDP. So why don’t we just do some direct job creation with part of the stimulus package, and get a hell of a lot of bang for our buck?
January 10th, 2009 at 3:18 pm
I can’t stop laughing at the 2-decimal-point precision given for the multiplier estimates. Did I miss the memo on error bars (which should be huge in this case) going out of style?
January 11th, 2009 at 8:04 am
I like Ben Ross’s Purple Line examples about redirected job skills. Additionally, there’s the rolling effect of the Lehman guy moving to another job that another person would have gotten, who then ends up in a somewhat different job, etc, ending up with someone with more appropriate skills in a stimulus-created job.
Push-out and pull-in – both end up with more people working (although not necessarily bringing in the same paycheck). And hopefully, more people creating actual, lasting value for the nation with our labor.
One of my major objections to our stinking employer-based health insurance system its gross distortion so many people’s job choices (not that the Bush economic disaster is an good counterweight).
January 11th, 2009 at 8:38 am
macroeconomics is junk
January 12th, 2009 at 2:22 pm
If we spent $10 trillion in 2009, all that debt wouldn’t screw things up as bad as if we left Section 128 of the EESA’08 bailout bill in place.
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