Tuesday, February 23, 2010

The Stimulus One Year Later According to Robert Barro

Robert Barro has an op-ed piece in today's Wall Street Journal. In it he opines on the effectiveness of the stimulus package, based on estimates of the government spending multiplier he has estimated. His estimates are less than unity, which means that an extra $900 billion of government spending leads to an increase in GDP of less than $900 billion. This differs from the claims made by others such as Paul Krugman, who believes the stimulus was vital but too small. I am unaware of any economic research Krugman has done on the spending multiplier, but he presumes that when there is slack in the economy, such as in a recession, the "crowding-out effects" that might occur in normal times will not take place.

But Krugman's arguments are based on the Keynesian model, which was rejected by much of the profession because of empirical evidence. It also is based on an over-arching concern on the short run. But, it was an emphasis on the short run, as exemplified by government, business, banks, and households, that helped create the problems we currently have. We may yet develop the situation that Keynesians believed after World War II--the economy was inherently unstable and persistent efforts by the federal government would be needed to maintain growth. If so, I believe a key reason for it will be government policies that focused so much on the short run that market forces were not permitted to provide a sustainable growth rate.

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