Why are economists so divided about the effectiveness of fiscal stimulus? As it turns out, the issue isn't as simple as it may seem. The fiscal multiplier is a critical component of the success of tax cuts or increases in government spending. The size of the multiplier is determined by many factors, including economic conditions, type of fiscal action, and how people react to higher government borrowing.
The Obama administration expects a multiplier of 1.6 for government purchases and 1.0 for tax cuts from the current fiscal stimulus. This is based on the assumption that the federal funds rate will remain constant for a 4-year period. Others estimate the stimulus will boost GDP by only one-sixth as much as the Obama team expects, using the assumption of a rise in interest rates and taxes in response to higher public borrowing.
It is very difficult to isolate the impact of changes in fiscal policy, so looking at historical data offers little help. To make things even more confusing, the current situation is different from the past because previous fiscal stimulus was focused on military spending. The conclusion? Economists can't predict the effect of the current fiscal stimulus with much certainty at all.
1 comment:
I found this article interesting, helpful, and informative (As a non-econ major, this article helps spell out very carefully the concept of multipliers). It is interesting to read about multipliers, and how different they seem to be from many economic concepts - they aren't easy to predict, nor is it helpful to look at historical data. The Obama team's prediction of how multipliers will work for the stimulus package would be beneficial if they are correct, but very unfortunate if the alternative assessment is correct. The US needs a drastic change, and hopefully the stimulus will do what it is intended to.
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