Why am I confident that multipliers that result from temporary decreases in government spending in current conditions will be somewhere around one rather than somewhere around zero? It is not because of empirical studies that try to directly estimate multiplier sizes.[skip]
Do not get me wrong. Such studies are very important, as are meta studies that try and pull together and synthesise the large number of individual studies. However I tend to use them to either confirm or question my priors. My priors come from thinking about models, or perhaps more accurately mechanisms, that have a solid empirical foundation. Let me explain.
Here my starting point is to note that because the increase in government spending is temporary, any impact on pre-tax income or taxes will be relatively small relative to a consumer’s lifetime income. As a result, aggregate consumption is likely to change either way by an amount that is a lot less than the cost of the school. For similar reasons firms think long term when planning investment, so they are not going to invest that much because of a temporary increase in government spending and GDP.the cost of the school is the increase in G
This is my usual comment. I think it might be well worth ignoring.
I get the impression that you consider the range of debate (the Overton window) to be from RBC to New Keynesian (with a bit of open-ness to aggregate modelling). The reason is that you consider only two possible beliefs about multipliers "will be somewhere around one rather than somewhere around zero"
You don't consider the possibility that the government spending multiplier (for an economy at the ZLB) might be well above 1, as it would be in a paleo Keynesian IS-LM model.
"any impact on pre-tax income or taxes will be relatively small relative to a consumer’s lifetime income. "
"My priors come from thinking about models, or perhaps more accurately mechanisms, that have a solid empirical foundation. "
Also perhaps less accurately. You have a strong prior that consumption mainly depends on lifetime not current income. Importantly, you are discussing macro and multipliers so you have a strong prior that aggregate consumption mainly depends on permanent not current income.
Yet you discuss strong empirical support. I ask whether there is any empirical support for your view. There is an over long timesome literature on testing the PIH, but there is not a similarly large literature on testing the hypothesis that only current and lagged income matters.
At the very least, there should be evidence of Ricardian effects -- that if one considers consumption and disposable personal income, then high budget deficits should correspond to surprisingly low consumption. I know of no evidence of this (of course I am considering market economies without legal rationing so not WWII).
Surprisingly high consumption should be followed by unusually rapid income growth. It is not for the USA.
What is the empirical basis for your beliefs that there is something to the PIH, and that the economy can be understood by assuming that consumption of the non-liquidity constrained roughly fits the PIH ?
I think consumption can be fit almost exactly using disposable personal income and the ratio of non-human wealth to disposable personal income. That non-human wealth includes a lot of common stock -- whose price is not correlated with future dividend growth (as noted by Robert Shiller).
Investment is highly correlated with GDP growth. It may be that firms should think of the medium term when choosing investment. I note that a large part of the cyclical variation of NIPA investment is variation of net inventory investment. I do not see why firms should think of the medium long term when choosing inventory levels. Another very important component of investment is residential investment -- that is the type which responds noticeably to real interest rates.
I think your priors come from thinking about models.
update: Stolen from Paul Krugman's comment thread trusted commenter Woof wrote
Woof! is a trusted commenter NY 13 hours ago
Two fiscal multipliers are commonly used (focusing on expenditure):
1. Impact multiplier=(∆Y(t))/(∆G(t))
2, Multiplier at horizon i=(∆Y(t+i))/(∆G(t))
So it would be useful to know to which PK is referring. It appears that he is talking about the impact multiplier.
Secondly, it matter if monetary policy is "normal" or if the CB implements a ZLB policy.
Based on a survey of 41 studies, Mineshima and others (2014) show that first-year "normal" multipliers amount on average to 0.75 for government spending in advanced economies.
But there is general agreement that at ZLB (zero interest policy) the fiscal multiplier can be higher.
Christiano and others in 2011, for the US, have a multiplier of 1.1 , but for ZLB implemented they estimate that initially the multiplier can be as high as 3.7
Eggertson 2010 has 0.5 , with 2.3 for ZLB. Erceg and Linde (2010) have a multiplier of 1, but at ZLB an initial multiplier of 4.
Finally, it has to be kept in mind that ZLB multipliers fall with time, and that the Fed's has operated at ZLB for several years , As always, the devil is in the details.
Fiscal Multipliers: Size, Determinants, and Use in Macroeconomic Projections By Nicoletta Batini, Luc Eyraud, Lorenzo Forni, Anke Weber, International Monetary Fund, Oct 2, 2014,