The Giant Chasm in Macroeconomics

Faced with an economic crisis, politicians want to know: What would make things better? Or more precisely, they want to know if boosting spending and cutting taxes will help or hurt the private economy.

Unfortunately, there’s a giant dispute among macroeconomists about precisely this question. I wrote about it here:

You might think these simple questions would have clear answers. Remember, macroeconomists have been studying the U.S. economy for decades. After all this time, we should have some general agreement on the size of the “multiplier”—that is, whether an extra dollar of government spending leads to gross domestic product, or GDP, going up by more than one dollar, or less than one dollar. To put it another way, it’s essential to know whether the Obama economic package will stimulate the private sector or actually drain resources away from the rest of the economy.

An Intellectual War In their analysis, the top Obama Administration economists, Christina Romer and Jared Bernstein, used a multiplier of roughly 1.6 for government purchases and about 1 for tax cuts. These figures suggest, for example, that a $100 billion increase in government purchases would lead to GDP going up by $160 billion. Out of that $160 billion, $100 billion would be the direct result of the original stimulus and $60 billion would be the increase in private-sector economic activity. A tax cut of $100 billion, by these numbers, would generate a $100 billion increase in GDP.

But among top economists, there is hardly consensus about the size of these multipliers, or even agreement about the right range. Instead, we are getting the equivalent of a full-scale intellectual war, with Nobel prize winners and leading economists actively attacking each other in public.

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