On multipliers

Richard Murphy writes:

[The government and OBR] believe that austerity generates growth and so cuts the deficit. The trouble for them is that all the evidence shows that the opposite is true: cuts shrink national income and government spending increases it.

This has attracted cheap abuse from some of Tim Worstall’s commenters. Such abuse is wrong, and misses the point.

It’s wrong, because - in the context he is writing about – Richard is right to claim that fiscal multipliers are big. There’s widespread agreement (pdf) that multipliers are bigger in recessions (pdf) than in normal times. For example, Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo say (pdf):

The government-spending multiplier can be much larger than one when the zero lower bound on the nominal interest rate binds.

The fact that Osborne’s austerity has failed to cut the deficit as much as expected is wholly consistent with this. Bigger multipliers than Osborne assumed meant that austerity depressed output by more than he expected thus making it harder to reduce borrowing.

In this sense, Richard’s critics are plain wrong.

However, multipliers aren’t always big. They vary. As Olivier Blanchard and Daniel Leigh wrote (pdf) in the IMF's mea culpa:

There is no single multiplier for all times and all countries. Multipliers can be higher or lower across time and across economies.

One important factor here is the monetary offset. When interest rates are high fiscal austerity would reduce rates, perhaps causing an expansionary fiscal contraction. When interest rates are zero and central bankers are unable (or unwilling) to undertake offsetting monetary policy, fiscal multipliers will be larger.

It’s in this context that I say that Richard’s critics are missing the point. One beef I have with his piece is that naïve readers might interpret his claim that multipliers are large not as a fact about the 2010-2015 period, but as a truth that holds all the time. This leads to the inference that a future Labour government should increase public spending considerably.

This, though, isn’t necessarily the case. If inflation is around its target, the Bank of England would respond to fiscal expansion by raising rates, resulting in a lower multiplier. This might or might not be a good thing – the appropriate fiscal-monetary policy mix is a legitimate matter of debate – but it would mean that the fiscal multiplier might be disappointingly small. (To put this another way, a fiscal expansion accompanied by an increase in the inflation target would have a bigger multiplier than one accompanied by retaining the 2% target.)

In this sense, advocates of a fiscal expansion after 2020 might be making the same error as advocates of expansionary fiscal contraction in 2010 – they are wrongly assuming that the same fiscal multiplier applies at all times. It doesn’t.

I’m making two points here, one about economics and one about politics. The economic point is to endorse what Dani Rodrik says in Economics Rules:

Different contexts – different markets, social settings, countries, time periods, and so on – require different models.

Economics is not like physics. In our discipline there are few if any reliable parameters.

The political point is that Labour supporters should not rely upon a big multiplier as a case for fiscal expansion. And not need they do so. Lots of leftist policies – such as tax and welfare reform or expanding worker ownership – can be designed without reliance upon fragile claims about the macroeconomy.

Comments

[Luis Enrique]

Is Richard right the OBR assumed negative multipliers, G down Y up? I'd be surprised

[chris]

No, he's not. They assumed lowish multipliers, consistent with the IMF's assumption of a 0.5 one. My point is simply that this was an under-estimate; it's in this sense that I agree with Richard

[Bob]

Against the concept of fiscal multipliers:

http://www.3spoken.co.uk/2013/05/the-misuse-of-fiscal-multiplier.html