Scott Grannis asserts that the multiplier associated with fiscal stimulus is roughly zero, and evidence over the past few years suggests that he may be right. He appeals to a form of the classic “crowding out” argument: that debt-financed increases in government spending absorb private saving, leaving less funding available for private capital investment. In the present case, federal deficits ($7.4 trillion since 2009) have soaked up more than 80% of the corporate profits generated over that time frame. Profits are a major source of funds for private capital projects, risky alternatives against which the U.S. Treasury competes.
There are other reasons to doubt the ability of fiscal policy to offset fluctuations in economic activity. Transfers, which have grown dramatically as a percentage of federal spending, can create negative work incentives, thereby diminishing the supply of labor and adding cost to new investment. The growth of the regulatory state adds risk to privately invested capital as well as hiring. Government projects also offer tremendous opportunities for graft and corruption, at the same time diverting resources into uses of questionable productivity (corn, solar and wind subsidies are good examples). Many federal programs in areas such as education fail basic tests of success. Federal bailouts tend to prop up unproductive enterprises, including the misbegotten cash-for-clunker initiative. Even government infrastructure projects, heralded as great enhancers of American productivity, are often subject to lengthy delays and cost overruns due to regulatory and environmental rules. Is there any such thing as a federal “shovel-ready” infrastructure project?
In recent years, research has found that spending multipliers are small and often negative in the long run, contrary to what statists and old-time adherents of Keynes would have you believe. Empirical multipliers tend to be smaller in more open economies and under more flexible exchange rate regimes. Of growing importance to many developed economies, however, is that spending multipliers tend to be zero or even negative in the long run when government debt is high relative to GDP. This is broadly consistent with the classic crowding-out explanation for low multipliers, whereby public debt burdens absorb private saving. U.S. government debt-to-GDP is now well above 60%, an empirical point of demarcation separating high and low-multiplier countries. Finally, some economists believe that fiscal stimulus is frequently offset by countervailing monetary tightening under an implicit policy of nominal GDP targeting. Scott Sumner describes this as the story of the past few years, as neither the fiscal expansion of the 2009 stimulus plan nor the contraction of the fiscal cliff and sequestration had much if any observable impact on economic growth.
Politicians, the mainstream press and eager Keynesian economists are seemingly always ready to pitch fiscal policy and higher federal spending as the solution to any macroeconomic problem. Sadly, that is unlikely to end any time soon, because the story they tell is so simple and tempting, and they are blind its insidious nature.