Innovation/Global Crisis Blog

A Modest Proposal for Responsible Fiscal Stimulus

By Shlomo Maital

   Frankly, having taught the course for 40 years, there is not much real value in Macro Economics 101.  Macro-economists, even superb Nobel Laureates like Joe Stigler, have very little to say about how the world can get out of its current mess.  Stiglitz, writing in the Financial Times, says the good news is…it could have been much worse.  And that, my friends, is about all he has to say.  The good news is, there might have been more bad news. Lovely.

  Here is a modest little idea that comes straight from the pages of Macro Economics 101.  It is called the Balanced Budget Multiplier. It was discovered by MIT Nobel Laureate Paul Samuelson, the greatest economist of his generation.  Here is his theorem:

    If governments increase their spending by $X b.,  and at the same time increase their tax revenue by $X b.,  the net effect on GDP is precisely  + $X b.  No deficit increase, but significant fiscal stimulus.

    Why? How can this be true, if the government absorbs $X b. in taxes and then just puts it back?  The reason is this:  If people kept the $X b. in income, they would spend only a part of it.  But the government spends ALL of it.  We know there is a pass-through or multiplier effect:  if people spend “c” percent of their income, the ‘multiplier’ is  1/c – i.e.   $1 in stimulus creates  1/(1-c) in new GDP;  if c is 0.8,  then the multiplier is 1/0.2 or 5. 

    So the net effect of a balanced-budget stimulus is  what the government spends, $X, minus what people would have spent with the $X in taxes, or  (c)$X,  or (1-c)$X, times the multiplier 1/(1-c),  which is  …. $X.    

   Simple? 

   Attention Tea Party advocates, including Rick Perry, Texas governor and probably the next Republican Presidential candidate (watch Mitt Romney fade).   You CAN have your cake and eat it too.  Raise govt. spending.  Raise tax revenue by closing loopholes (technically, NOT a tax increase).  Balance new spending with new revenue.  Avoid raising the deficit. And yet, at the same time, stimulate the economy and create jobs. 

    This idea comes from Robert Shiller, NYT July 23.  Shiller is a rarety, a truly creative macroeconomist with a great many cool ideas for resolving the current crisis.  He has a new book coming out soon that is eagerly awaited.