TightWind is written by Kyle Baxter. Stay Hungry. Stay Foolish.

Robert Barro on the multiplier effect:

A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP — consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.

This approach is the one usually applied to cost-benefit analyses of public projects. In particular, the value of the project (counting, say, the whole flow of future benefits from a bridge or a road) has to justify the social cost. I think this perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.

Not only is that a more reasonable and rational standard to apply to government projects than the assumption many are making — that the multiplier is more than one (up to 1.5 times), which justifies nearly any government spending as “stimulus” and thus as reasoning for passing any spending desired — but Barro estimates past multipliers to be much less than 1. At its height during World War 2, he estimates it to be .8x; during peace time, he estimates it to be “insignificantly” different than zero.

If we use a multiplier of zero standard, which we should because it insures the value created by spending overcomes its social costs, then many parts of the bill passed Friday would be unjustified.