At the center of the debate over efforts by policymakers to “stimulate” the economy with government spending is the issue of fiscal multipliers. Some economists argue that government spending can be a free lunch: an additional dollar of government spending increases GDP by more than one dollar.
Other economists say that government spending is not so free: an additional dollar of government spending increases GDP by less than one dollar or even reduces it.
My non-empirically based view is that the mainstream media tends to treat the free lunch position as gospel. Why that appears to be the case I’ll leave to others to speculate, but it is decidedly irritating.
Back in 2010, my colleague Alan Reynolds noted that a survey conducted by an economist at the Federal Reserve Bank of San Francisco counted several studies that concluded that the multiplier effect of government spending is less than one.
We can now add to the list another study that found a multiplier of less than one.
From a National Bureau of Economic Research working paper by economist Valerie Ramey:
For the most part, it appears that a rise in government spending does not stimulate private spending; most estimates suggest that it significantly lowers private spending. These results imply that the government spending multiplier is below unity. Adjusting the implied multiplier for increases in tax rates has only a small effect. The results imply a multiplier on total GDP of around 0.5.
Note: For readers who are interested in real world examples of how government spending hinders economic growth, check out DownsizingGovernment.org.