Murphy et al. on Stimulus

January 28, 2009

For a while, this video was getting a lot of discussion from the economics blogs. The reason is pretty simple: it’s excellent.

Kevin Murphy provides a useful framework for understanding whether government spending is worth it. He expresses the condition as 

f(1-λ) > α + d

where

α – “inefficiency” of government spending, how much less valuable is government spending than private spending

d – deadweight loss from tax collection to pay for spending

f – the stimulative effect of spending, how much comes  from unused resources (a multiplier of 1.5 means f is 1.5)

λ – the non-market value of unused resources (presumably if you are unemployed you still do not value your time at zero, otherwise laid-off stockbrokers would be working in fast food)

As Murphy says, the good thing about his model is that pretty much anyone can use it, pro-stimulus or not. From what I’ve seen, the argument comes down to alpha. Murphy thinks it’s positive, people like Mark Thoma and Brad DeLong thing that it is zero or negative. This is why the debate splits pretty cleanly on partisan lines. People who think that government spending is more valuable than private spending anyway (negative alpha) want government to spend more money. As Thoma writes, “Tax cuts won’t build schools, or any other public good.”

The clearest implication of the model is that it’s really hard to make stimulus worthwhile unless you think that alpha is low or negative. The “stimulus benefit” (f(1-λ)) just isn’t that large under reasonable assumptions. Hence, as I say, the clean partisan split. Whether you are pro-stimulus or anti-stimulus comes down to whether you want government to spend more money in non-recessionary times. The model forces us to make that preference explicit.

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