What About a Stimulus That Works!

Everyone agrees that what the world needs now is Stimulus.

But what kind of stimulus should it be? Should it be a tax rate cut, as Republicans and conservatives would recommend? Or should it be spending on stuff like infrastructure, as Democrats and liberals would recommend, and as President-elect Obama seems to prefer?

Harvard economics prof Greg Mankiw has some ideas on this. And like a true economist, he grades the different approaches by their “multiplier” effect. Here is what he means:

One way to think about the issue is the size of the fiscal policy multipliers. The multipliers measure bang for the buck—the amount of short-run GDP expansion one gets from a dollar of spending hikes or tax cuts.

That’s a fancy way of saying: If I spend a dollar on stimulus, how far would it go?

Guess what. Republicans are right and Democrats are wrong.

In their new blog, Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government spending multiplier is about one: A dollar of government spending raises GDP by about a dollar. Similarly, the results in Valerie Ramey’s research suggest a government spending multiplier of about 1.4.

Oh goody. The spending stimulus goes down like a lead balloon. But what about the prescription of eevil mean-spirited Republicans?

By contrast, recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars.

Well now. That is what you call a real bang for the buck, as they say Out West.

But this is exactly what conservatives would expect. What matters, we conservatives believe, following the 1870 marginal revolution in economics, is economic decisions on the margin. The way to stimulate the economy is to reduce the marginal cost for workers to work and investors to invest. You do that by cutting marginal tax rates on labor income and capital gains.

This is not rocket science. It is 140 year old science.

But liberals aren’t interested. If they were to accept the ideas of marginal economics then they would have to dismantle their vast, tottering patronage and client state.

Naturally, they won’t do that. Because their liberal client state is the foundation of their political power.

You’ll recall that all power corrupts, and absolute power corrupts absolutely. When you live by political power you get Chicago politics and politicians like Gov. Blagojevich (D-IL).

Something to think about, Mr. President-elect.