The economic theory driving the $800 billion Obama stimulus holds that government spending has a multiplier, especially during tough economic times. For every $1 of spending, overall GDP increases by more than $1, maybe $1.50 or so. That is pretty much what Team Obama assumed.
But there are lots of theories and studies about fiscal multipliers. Some even hold that for every $1 of government spending, we get less than $1 of output — and that’s not even taking into account that higher taxes will be needed to pay for debt-financed stimulus.
“Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data,” a new study from economists at the St. Louis Fed, University of California, San Diego, and the Bank of Canada, looks at fiscal multipliers during periods of economic “slack” over the past hundreds years or so, which they define as periods of 6.5% or higher unemployment in the U.S., 7.0% of higher unemployment in Canada. As does economist Robert Barro in his work, economists Michael Owyang, Valerie Ramey, and Sarah Zubairy concentrate on the impact of defense spending (via the American Economic Association annual meeting):
We have investigated the proposition that multipliers are greater during periods of slack using newly constructed historical data for the U.S. and Canada. Using Jordà’s (2005) local projection method, a threshold model based on the level of the unemployment rate, shocks to military news, and definitions of variables that obviate the need for ad hoc conversion factors, we find no evidence that multipliers are higher during periods of slack in quarterly U.S. data from 1890 to 2010. In all states, multipliers appear to be between 0.6 and 0.7.
In contrast, estimates using quarterly Canadian data from 1921 to 2011 indicate that multipliers are typically greater during periods of slack. The multipliers are around 0.5 during the nonslack state, but are above unity during the slack state at many horizons. It is important to point out, though, that because we do not adjust for the fact that taxes often rise at the same time as government spending, these estimated multipliers are not necessarily equal to pure deficit-financed multipliers.