The Multiplier for Federal Spending During the New Deal
The output multiplier associated with federal spending is likely to be lower today than during the New Deal period.
The 2009 federal stimulus package has generated new interest in measuring the effect of government spending in raising overall economic activity. This is sometimes labeled the "output multiplier." It is a measure of the rise in income associated with an additional dollar of government grants. A multiplier of 1.5 implies that an additional dollar of grants raises income by the dollar of grants plus 50 cents; a multiplier of 0.5 implies that an added dollar or grants increases income by only 50 cents and thus crowds out some economic activity. In In Search of the Multiplier for Federal Spending in the States during the New Deal (NBER Working Paper No. 16561), Price Fishback and Valentina Kachanovskaya examine the impact of federal stimulus programs during the Great Depression on a state-by-state basis. They estimate that for personal income, which includes transfer payments, the multiplier ranges from 0.91 for a combination of government grants and loans to 1.39 when only grants are considered. The personal income multiplier for public works and relief was around 1.67. The multiplier for farm payments to take land out of production was -0.57, which implies that the program actually reduced personal income.
The multiplier for wages and salaries was substantially less than one, as was the multiplier for retail sales. Furthermore, the researchers find that the impact of the federal spending on employment was negligible and may have been negative. These results may help to explain why measures of income have recovered more rapidly than measures of employment in both the 1930s and in the current era.
To estimate the Depression-era multiplier, Fishback and Kachanovskaya create a dataset with annual information on the 48 contiguous states from 1930 through 1940 for federal government grants, loans, and tax collections, and a variety of measures of economic activity. The data show that real federal tax revenues per capita in 1935 ranged from $3 in Mississippi to $321 in Delaware, while federal grant spending per capita ranged from $46 in Rhode Island to $506 in Nevada. The authors choose to study this period because unemployment rates were between 9.5 and 25 percent throughout those years. Given the large number of unemployed resources at the time, it seems that fiscal stimulus would have been unlikely to crowd out private activity, so the multiplier would be expected to be quite large.
The authors conclude that, given the differences in unemployment levels between the 1930s and today, the output multiplier associated with federal spending is likely to be lower today than during the New Deal period. Their rough estimate is that the current multiplier would be one or less for personal income, which includes transfer payments, and smaller for other measure of income.
--Matt NesviskyThe Digest is not copyrighted and may be reproduced freely with appropriate attribution of source.