Matthew Yglesias agrees that Kevin Murphy gives the:
Best Anti-Stimulus Argument I’ve Seen: Kevin Murphy’s slides here. I think he overstates the deadweight loss effect and is working with the wrong conception of “efficiency” for these purposes when he claims that government is inefficient, so the odds of a stimulus being successful therefore aren’t as bad as he indicates. And this doesn’t change the fact that I haven’t heard any better ideas than doing a big stimulus. But this is a sobering reminder that a big stimulus doesn’t guarantee success—very hard work needs to be done on making sure that stimulus funds target genuinely idle resources rather than diverting non-idle resources while leaving the idle ones as idle as ever.
Here is Kevin:
Evaluating the Fiscal Stimulus
Kevin M. Murphy
January 16, 2009
A Framework for Thinking about the Stimulus Package
- Let G = increase in government spending
- 1-α= value of a dollar of government spending (α measures the inefficiency of government)
- Let f equal the fraction of the output produced using “idle” resources
- Let λ be the relative value of “idle” resources
- Let d be the deadweight cost per dollar of revenue from the taxation required to pay for the spending
When Will the Stimulus Add Value?
The net gain is the value of the output produced less the costs of the inputs and the deadweight loss
In terms of the previous notation we have: Net Gain = (1-α)G –[(1-f)G + λfG] –dG
- Net gain = (f(1-λ) –α–d)G
- A positive net gain requires that: f(1-λ) > α+d
- Difference of opinion comes from different assumptions about f, λ, α, and d
My View * α likely to be large * Government in general is inefficient * The need to act quickly will make it more inefficient * The desire to spend a lot in a short period of time will make it more inefficient * Trying to be both stimulus and investment will make it even more inefficient * 1-f likely to be positive and may be large * With a large fraction of resources employed (roughly 93%) much will be drawn from other activities rather than “idle” resources * Ricardian equivalence implies that people will save to pay for future taxes reducing private spending * λ is non-zero and likely to be substantial * People place positive value on their time * Unemployed resources produce value through relocation (e.g. mobility & job search) * d is likely to be significant * Wide range of estimates of d * Estimates based on the analysis of taxable income imply d≈0.8 * With these parameters the stimulus package is likely to be a bad idea
As I read it, Kevin thinks α = 1/2, f = 1/2, λ = 1/2, d = 0.8, and gets 0.25 > 1.3. I would say that α = 0 (increasing income inequality and starvation of the non-health non-military public sector over the past generation have left a bunch of low hanging fruit), f = 1.5 (there are multipliers out there, and markets work if there is sufficient demand: as long as there are idle resources people will use them first as long as demand is available), λ = 1/5 (the cyclically unemployed are not having much fun), and d = 1/3. So I get 1.2 > 0.33.
More interesting, I think, is that there is an unemployment rate at which Kevin Murphy's priors would switch and he would become a stimulus advocate. What is it?