Hello. There is No Magic Money Multiplier

Mish

Let's ponder the "Magic Multiplier" concept.

Magic Multiplier Theory

Veronique de Rugy discusses When Puff the Magic Multiplier Goes Poof.

The belief is that when the government takes a dollar out of your pocket, puts that dollar through the political process and decides where to spend it (based on input from special interest groups), the economy will somehow return more money in growth than the money invested, even after Washington bureaucrats take their cut. It's magic! Sadly, these arguments ignore recent empirical evidence that the costs of increased government spending far outweigh the benefits to the economy.

After reviewing the recent academic literature for the Mercatus Center's publication The Bridge, my colleague Jack Salmon and I found that most of "the empirical literature on fiscal multipliers conducted since then (2009) has found economic multipliers resulting from additional government spending ranging from a lower estimate of around 0.2 to an upper estimate of around 0.9." We go on to explain that in "(p)ulling the results from two dozen academic studies, we calculate an average multiplier at the low end of 0.31 and an average multiplier at the high end of 0.66."

There are always economists, journalists and pundits willing to assume that this time will be different and government spending will deliver on the promises made on its behalf by pro-spending advocates. Unfortunately, this is wishful thinking. It is also a dangerous game to play. If spending doesn't deliver on the promised economic growth, what it will undoubtedly achieve is more debt. That, sadly, is a scenario where future growth goes up in a puff of smoke.

No Magic Multiplier, Only Debt

The headline title is a bit misleading. It sounds as if there is a multiplier about to go poof.

There is a temporary demand shift forward but at a huge cost.

Long-term, the multiplier is negative for many reasons.

Negative Multiplier Due To:

  1. Increased long-term debt.
  2. Zombification of unproductive companies at the expense of healthy ones.
  3. Taking money from productive segments of the economy to relocate them to segments performing poorly is poor policy. 
  4. Government can never allocate money wisely. Only the free market can. 

Let's not confuse the alleged short-term benefit of .31 to .66 (assuming it happens at all), with magic.

Ho, Ho, Ho!

Ho, Ho, Ho, It's NOT Magic. It's just foolish. Debt and deficits are proof.

Mish

Comments (35)
WildBull
WildBull

0.33 ...??? That says the the money would have been allocated 3X better if left in the pockets of the people that earned it. We already know that.

Cocoa
Cocoa

If I recall due to prevailing wage laws and unions, Mish mentioned that average gov job versus a private sector job is at face value, $6000 more cost to hire a government worker. And then with pensions and benefits for life, the salary cost is 2x private sector! So, a lot of that money is just wasted and we could probably hire 2x more people to do work and increase employment if government workers did not get so much

Tony Bennett
Tony Bennett

The last 3 weeks M1 has risen.

The last 3 weeks M2 has dropped.

TCW
TCW

Votes are expensive!

Six000mileyear
Six000mileyear

If there is no magic multiplier, then we need to get rid of ALL welfare (corporate and individual), foreign aid, and foreign military occupation immediately.

Tony Bennett
Tony Bennett

"Sadly, these arguments ignore recent empirical evidence that the costs of increased government spending far outweigh the benefits to the economy."

...

The Republican Fable / Con for years was supply side economics. Bush called Reaganomics (when he was running against him) Voodoo Economics. That by cutting taxes the extra growth would more than pay for tax cut. Back in 2005 or so (when Republicans held Congress therefore controlled CBO) the CBO came out with a report on Voodoo Economics, er, supply side BS. Ran multiple simulations. Iirc, the worst case added growth only generated enough extra taxes to replace 8% of tax cut ... best case was around 22% replacement. The weak growth fleeting ... the added debt ... Forever.

Pater_Tenebrarum
Pater_Tenebrarum

Deficit spending is akin to pumping water from the deep end of the swimming pool to the shallow end using a leaky hose.

Jam_Ham
Jam_Ham

No one sees the cost of debt with such low interest rates. Still counts tho!

Sechel
Sechel

I would have responded earlier but I took the day off to do some cycling. Seems like one can go shopping for the number that fits one's ideology.

III. Why Do Multiplier Estimates Vary Widely?The variation in estimates of the fiscal multiplier cannot be explained by economists’ use of different types of models. Each type described above can generate a broad range of multiplier estimates. For example, Reichling and Whalen (2012) find estimates for the United States, as measured (on a cumulative basis) after eight quarters, ranging from 0.75 to 2.25 for macroeconometric forecasting models, from 0.3 to 3.5 for time series models, and from 0.5 to 2.25 for DSGE models. To better unde
rstand the variation in multiplier estimates, one must consider analytical and measurement issues, fiscal policy details, economic conditions, and how fiscal policy can affect people’s confidence in the future of economic activity.

Casual_Observer
Casual_Observer

Negative rates !

Democritus
Democritus

Sure, but there is a certain curve. The first 20% GDP spent by the government might be very efficient or necessary, then less and less so. Depending upon what you want to optimize in your country (GDP, employment, happiness, net income, military might, etc etc) there is the right amount to tax and spend. Maybe 25.5% for max GDP, 41.3% for max employment, 39.4% for max happiness - your guess is as good as mine. Surely going towards 100% has been proven a pretty bad idea.