Hoisted from Comments: Richard Green writes:
Grasping Reality with Both Hands: Council on Foreign Relations Wingnut Watch: Benn Steil: I am glad that Barro's logic escaped you, as well. As I am not a macroeconomist, I figured that it was I who was dense. But it seemed to me that the facts presented in the article showed that even an enormous stimulus that burned a lot of resources (building tanks and ships that will be destroyed are kind of like bridges to nowhere, economically) had very little crowding out effect.
The context is Benn Steil's claim that Robert Barro's January 22, 2009 Wall Street Journal op-ed "provides logic and offers evidence" to support Steil's claim that the interest elasticity of money demand is zero and thus that the fiscal multiplier is zero too.
As I said before, the evidence that Barro presents suggests a multiplier for temporary government purchases not of Steil's zero but instead of 0.8:
Robert J. Barro: Government Spending Is No Free Lunch: Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II.... I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540).... We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War.... Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before...
But it is the logic that most puzzles me. Barro writes:
The [Keynesian] theory... assumes that the government is better than the private market at marshaling idle resources.... Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system. John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved -- but economists have not come up with explanations, such as incomplete information, for multipliers above one...
If I read this paragraph correctly, Barro thinks (a) there are theoretical reasons to think that the fiscal multiplier cannot be greater than one, and (b) there are theoretical reasons for thinking that if you believe in positive fiscal multipliers you should also believe that expansionary monetary policy that raises the flow of nominal spending will also raise employment and production--which people do, for it is only when they fear that monetary policy is tapped out and cannot raise the flow of nominal spending any more that they fear that monetary policy may be ineffective.
So I don't understand how Barro gets to his very next sentence:
A much more plausible starting point is a multiplier of zero...