I was watching Bill Maher interview Christy Romer the other night. My macro professor sent out a link to the interview. Bill said that more stimulus would solve our GDP issues as the original recession was much worse than expected. Besides this strategy being politically infeasible, Bill needs to realize that the government can't just spend it's way out of this mess. To demonstrate this, let's look at a few points:
1. It's true that GDP = C + I + G. However, G is equal to a*g, where 'a' is the multiplier of spending and 'g' is the spending allocated by government.
2. There are costs to spending today that need to be considered.
3. Most importantly, an increase in G may "crowd out" investment, I.
First, there is a multiplier to the effect of government spending. Empirically, different economists have found this multiplier to range from 0.3 to 1.5. It must be stated that increasing government spending will increase output but the effect may not be 1-1, and this needs to be taken into account since....
There are costs to spending today! Spending today is "negative savings" and this negative savings is paid for by the next generation. Stimulus today will help with output in the short run, but there may be long term costs to a higher deficit. This last fact was debated ad nauseam in the recent debt ceiling negotiations. These negotiations are occurring because of the long term costs to high spending. My view is that the US clearly needs to address it's long term fiscal issues, but deep spending cuts in the next few years should be avoided until at least 2013.
(this part is a little wonkish, reader beware)
Lastly, increasing G will shift out the IS curve, which increases Y (GDP) but at the same time, increases nominal interest rates, r. An increase in 'r' will decrease investment by firms, I, today since the cost of capital for firms has increased. Therefore, the increase in G has an offsetting effect of decreasing firm investment, another component of GDP.
Concluding, it's easy to say that increasing G will solve all of our problems, but that is not economically correct. In the very least, if Bill is going to recommend increasing G, he must address the government multiplier effect and crowding out of investment - two things which don't have definitive empirical conclusions.
1. It's true that GDP = C + I + G. However, G is equal to a*g, where 'a' is the multiplier of spending and 'g' is the spending allocated by government.
2. There are costs to spending today that need to be considered.
3. Most importantly, an increase in G may "crowd out" investment, I.
First, there is a multiplier to the effect of government spending. Empirically, different economists have found this multiplier to range from 0.3 to 1.5. It must be stated that increasing government spending will increase output but the effect may not be 1-1, and this needs to be taken into account since....
There are costs to spending today! Spending today is "negative savings" and this negative savings is paid for by the next generation. Stimulus today will help with output in the short run, but there may be long term costs to a higher deficit. This last fact was debated ad nauseam in the recent debt ceiling negotiations. These negotiations are occurring because of the long term costs to high spending. My view is that the US clearly needs to address it's long term fiscal issues, but deep spending cuts in the next few years should be avoided until at least 2013.
(this part is a little wonkish, reader beware)
Lastly, increasing G will shift out the IS curve, which increases Y (GDP) but at the same time, increases nominal interest rates, r. An increase in 'r' will decrease investment by firms, I, today since the cost of capital for firms has increased. Therefore, the increase in G has an offsetting effect of decreasing firm investment, another component of GDP.
Concluding, it's easy to say that increasing G will solve all of our problems, but that is not economically correct. In the very least, if Bill is going to recommend increasing G, he must address the government multiplier effect and crowding out of investment - two things which don't have definitive empirical conclusions.
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