Spending During a Recession Is an Even Better Idea Than We Thought

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Matt O’Brien points today to a new paper that tries to estimate the value of the fiscal multiplier during recessions. The multiplier is a number that tells us how effective government spending is. For example, if the government spends a dollar on donuts, and then the baker uses part of that dollar to buy sugar, and then the sugar distributor uses part of that to pay her truckers, then the original dollar of government spending might spur total spending of more than a dollar.

On the other hand, if government spending simply takes a dollar out of the pockets of taxpayers, the net effect might be zero. Total spending might not change at all.

The value of the multiplier during the Great Recession has been a subject of considerable dispute over the past few years, but a new trio of researchers has produced an estimate higher than most previous ones:

Riera-Crichton, Vegh, and Vuletin took this analysis a step further. They focused squarely on countries that, between 1986 and 2008, had both been in a recession and increased spending. This last point is critical. Stimulus, remember, is supposed to be countercyclical: the government spends more when the economy shrinks. But historically-speaking, countries have actually cut spending about half the time that they’ve been in a slump. So counting all that austerity as “stimulus,” as most do, gives us a misleadingly low estimate of the multiplier, something like 1.3. But it turns out, based on this new better sample, that the multiplier is really around 2.3 during a garden-variety recession, and 3.1 during a severe one.

Hmmm. I can’t say that I understand this. Every estimate of the fiscal multiplier I’ve seen acknowledges that it’s different during recessions. And why would previous research have included countries that cut spending during a recession? This is a bit of a mystery. Nonetheless, if this new paper really does do a better job of estimating the multiplier, then it makes a very strong case that stimulus spending during a recession—especially a severe one—is critical to recovery. America’s obsession with austerity starting in 2011 is probably a big reason our recovery was so weak, and cutting spending now, as the eurozone is doing even as its economy decays yet again, is the worst thing they could do.

More infrastructure spending, please. After all, why not do it now when it’s practically a free lunch?

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