A key issue facing the new Obama administration is to what extent the economic stimulus should take the form of spending increases versus tax reduction. One way to think about the issue is the size of the fiscal policy multipliers. The multipliers measure bang for the buck–the amount of short-run GDP expansion one gets from a dollar of spending hikes or tax cuts.
So what are these multipliers? In their new blog, Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government spending multiplier is about one: A dollar of government spending raises GDP by about a dollar. Similarly, the results in Valerie Ramey’s research suggest a government spending multiplier of about 1.4. (Valerie does not present her results in multiplier form, but she emails me this translation: “The right column of figure 5A of my paper shows that for a log change of government spending of 1, log GDP rises by 0.28, implying an elasticity of 0.28. To back out the implied multiplier, we can use the fact that government spending averages around 20% of GDP. This implies a multiplier of 1.4.”)
By contrast, recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars. Continue reading . .
