Jackson Jambalaya

Found a little study that will cause the Krugonauts to gnash their teeth as it takes issue with the assertion by Krugman, the Obama administration, and Keynesians that more government spending will stimulate the economy. Such advocates argue that for every dollar spent by government, GDP increases 1.5 times. A new study, New Keynesian versus Old Keynesian Government Spending Multipliers by Drs. Cogan, Cwik, Taylor, and Wieland*, concludes the opposite is true and that such spending puts a drag on the economy.

From the abstract:
"Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. ..... Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large and with private sector employment impacts likely to be even smaller."

The remaining quotes are from the study itself. The study cites on flaw in the models that posit a multiplier of 1.5:
"(Such models) assume that the Federal Reserve pegs the interest rate—the
federal funds rate—at the current level of zero for as long as their simulations run. Given their assumption that the spending increase is permanent, this means forever..." (Does anyone think interest levels will stay at zero?)

However, the study then states such a model will cause.........hyperinflation:
"With the Fed holding the nominal interest rate constant at the current value near zero, and thus below inflation, the lower real rate would cause inflation to rise and accelerate without limit. Thus the combination of a permanent increase in government spending and the Fed setting the interest rate at zero would lead to hyperinflation..."

The study also argues that in addition to hyperinflation, the economy will contract more and more as so-called stimulus spending increases:
"The Smets-Wouters model predicts that the increase in GDP by the end of 2009 is
smaller than the increase in government expenditures itself; that is, the multiplier is less than one. Thus, the model predicts that government “stimulus” quickly produces a permanent contraction in private sector investment and/or consumption. Note that the magnitude of the contraction grows over time. By the end of 2012, for each dollar of “stimulus”, the flow of goods and services produced by the private sector falls by sixty cents...."

Read the rest of the study (its only 21 pages, double-spaced): http://www.volkerwieland.com/docs/CCTW%20Mar%202.pdf

*"John F. Cogan is the Leonard and Shirley Ely Senior Fellow at the Hoover Institution and a professor in the Public Policy Program at Stanford University. John B. Taylor is the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution Mary and Robert Raymond Professor of Economics at Stanford University. Tobias Cwik is a doctoral candidate in economics at Goethe University Frankfurt. Volker Wieland is Professor for Monetary Theory and Policy at Goethe University of Frankfurt and Willem Duisenberg Research Fellow at the European Central Bank."