Via Greg Mankiw, we learn of new research on Keynesian Government Spending Multipliers, which suggests the Obama administration used overly optimistic estimates to support President Obama’s ever-shifting goal — create or save 3.5 million jobs.
The multiplier is the amount that a change in government spending or tax cuts will increase GDP. For instance, a multiplier of one means that a $1 increase in government spending results in a $1 increase in GDP. A multiplier greater than one means that a spending increase or tax cut has secondary effects that further boost GDP.
According to the Heritage Foundation experts, to sell Obama’s massive bailout boondoggle, the so-called stimulus, the administration relied upon a report prepared by Christina Romer, chair of the President’s Council of Economic Advisers, and Jared Bernstein, the Vice President’s chief economist:
The Romer–Bernstein report finds that the stimulus plan will create about 3.7 million jobs and reduce the unemployment rate by about two percentage points from where it would have been without the stimulus by the fourth quarter of 2010. The report is supposed to lend academic creditability to a plan based on political considerations, but the estimates created are founded on loose assumptions that lack academic rigor.
Romer and Bernstein rely upon the wrong multiplier:
The Romer and Bernstein multipliers for government spending and tax cuts were estimated by the Federal Reserve’s FRB/US model and a leading private forecasting firm. They settle on a multiplier of approximately 1.5 for government spending and about 0.99 for tax cuts. This would suggest that for every dollar the government spends, GDP increases $1.50, while every dollar in lower government taxes increases GDP by just under a dollar.
The new research supports the Heritage foundation experts:
We find that models currently being used in practice to evaluate fiscal policy stimulus proposals are not robust. Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large and with private sector employment impacts likely to be even smaller.
[. . .]
We find that the government spending multipliers from permanent increases in federal government purchases are much less in new Keynesian models than in old Keynesian models. The differences are even larger when one estimates the impacts of the actual path of government purchases in fiscal packages, such as the one enacted in February 2009 in the United States or similar ones discussed in other countries. The multipliers are less than one as consumption and investment are crowded out. The impact in the first year is very small. And as the government purchases decline in the later years of the simulation, the multipliers turn negative.
The estimates reported here of the impact of such packages are in stark contrast to those reported in the paper by Christina Romer and Jared Bernstein. They report impacts on GDP for a broad fiscal package that are six times larger than those implied by government spending multipliers in a typical new Keynesian model and our calculations based on generous assumptions of the impacts of tax rebates and transfers on GDP. They also report job estimates that are six times larger than these alternative models, and the impacts on private sector jobs are likely to be at variance with the alternative models by an even larger amount. At the least, our findings raise serious doubts about the robustness of the models and the approach currently used for practical fiscal policy evaluation.
Get ready for another stimulus boondoggle when the biggest spending bill in history fails to meet the overly optimistic projections set by the Obama administration.