http://krugman.blogs.nytimes.com/2009/01/06/stimulus-arithmetic-wonkish-but-important/
January 6, 2009, 9:26 am
Stimulus arithmetic (wonkish but important)
Bit by bit we’re getting information on the Obama stimulus plan, enough
to start making back-of-the-envelope estimates of impact. The bottom
line is this: we’re probably looking at a plan that will shave less than
2 percentage points off the average unemployment rate for the next two
years, and possibly quite a lot less. This raises real concerns about
whether the incoming administration is lowballing its plans in an
attempt to get bipartisan consensus.
In the extended entry, a look at my calculations.
The starting point for this discussion is Okun’s Law, the relationship
between changes in real GDP and changes in the unemployment rate.
Estimates of the Okun’s Law coefficient range from 2 to 3. I’ll use 2,
which is an optimistic estimate for current purposes: it says that you
have to raise real GDP by 2 percent from what it would otherwise have
been to reduce the unemployment rate 1 percentage point from what it
would otherwise have been. Since GDP is roughly $15 trillion, this means
that you have to raise GDP by $300 billion per year to reduce
unemployment by 1 percentage point.
Now, what we’re hearing about the Obama plan is that it calls for $775
billion over two years, with $300 billion in tax cuts and the rest in
spending. Call that $150 billion per year in tax cuts, $240 billion each
year in spending.
How much do tax cuts and spending raise GDP? The widely cited estimates
of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for
spending, with widely varying estimates for tax cuts. Payroll tax cuts,
which make up about half the Obama proposal, are pretty good, with a
multiplier of 1.29; business tax cuts, which make up the rest, are much
less effective.
In particular, letting businesses get refunds on past taxes based on
current losses, which is reportedly a key feature of the plan, looks an
awful lot like a lump-sum transfer with no incentive effects.
Let’s be generous and assume that the overall multiplier on tax cuts is
1. Then the per-year effect of the plan on GDP is 150 x 1 + 240 x 1.5 =
$510 billion. Since it takes $300 billion to reduce the unemployment
rate by 1 percentage point, this is shaving 1.7 points off what
unemployment would otherwise have been.
Finally, compare this with the economic outlook. “Full employment”
clearly means an unemployment rate near 5 — the CBO says 5.2 for the
NAIRU, which seems high to me. Unemployment is currently about 7
percent, and heading much higher; Obama himself says that absent
stimulus it could go into double digits. Suppose that we’re looking at
an economy that, absent stimulus, would have an average unemployment
rate of 9 percent over the next two years; this plan would cut that to
7.3 percent, which would be a help but could easily be spun by critics
as a failure.
And that gets us to politics. This really does look like a plan that
falls well short of what advocates of strong stimulus were hoping for —
and it seems as if that was done in order to win Republican votes. Yet
even if the plan gets the hoped-for 80 votes in the Senate, which seems
doubtful, responsibility for the plan’s perceived failure, if it’s spun
that way, will be placed on Democrats.
I see the following scenario: a weak stimulus plan, perhaps even weaker
than what we’re talking about now, is crafted to win those extra GOP
votes. The plan limits the rise in unemployment, but things are still
pretty bad, with the rate peaking at something like 9 percent and coming
down only slowly. And then Mitch McConnell says “See, government
spending doesn’t work.”
Let’s hope I’ve got this wrong.
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