I suspect this isn’t what the fiscal multiplier means

But I’ll admit I don’t actually know, not doing much macro:

In the paper Ronen Palan and I put it as follows:

The government forecaster – the Office for Budget Responsibility (OBR) – is adopting a low, and in our view, unrealistic multiplier for government spending (range of 0.6 to 1.0). This is much lower than the one adopted by the IMF (0.9 to 1.7) or Standard & Poor (up to 2.5). The low multiplier adopted by the OBR has led to persistent overestimation of the benefit of austerity and constant upwards revision of public borrowing needs.

The multiplier is explained here. In summary:

In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it.

To put it more directly: the government and Office for Budget Responsibility assume every pound of government spending shrinks national income and, in reverse, every pound of cuts increases national income.

24 thoughts on “I suspect this isn’t what the fiscal multiplier means”

  1. Aren’t there two things; a beneficial multiplier on government services (which presumably depends on what the money is spent on) and a detrimental multiplier on raising the tax to pay for it (which we know depends on what taxes you use)?

    The overall effect will then depend on the net of those two, which may be positive or negative depending on how the money is raised and what it’s spent on.

    The idea of a single multiplier applying to all government spending looks like Keynsian bollocks to me.

  2. looks about right to me.

    Richard you might want to ask about what spent on, how funded etc. and the answers to those questions will matter, but there’s nothing bollocks about estimating the reduced form relationship change G / change Y (so long as you understand what you are doing).

    IMF has publicly admitted is got multipliers to low with its forecasts for peripheral EU.

  3. On the subject of bollocks….the entire multiplier idea is bollocks. Many economists attach importance to it on the grounds that if a particular type of government spending results in say £3 worth of extra GDP for each extra £1 of govt spending, that’s supposed to be value for money compared to where £1 of govt spending produces say just £1.5 of extra GDP. The flaw in that idea is that stimulus costs nothing in real terms, thus it really doesn’t matter what the multiplier is.

    When I say stimulus costs nothing, what I mean, to illustrate, is that printing an extra £1bn and spending it costs nothing (apart from the cost of running the metaphorical printing press).

  4. In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it.

    OK, so if the multiplier is 0.6, an increase in government spending of £1 causes an increase in national income of 60p.

    To put it more directly: the government and Office for Budget Responsibility assume every pound of government spending shrinks national income…

    Pardon?

  5. SJW,

    Where’s the other 40p gone? If you meant national income grows by an *additional* 60p then shouldn’t the multiplier be 1.6x?

    Perhaps the IMF and Standard & Poor multipliers are being correctly described while the OBR one isn’t.

  6. Couple of points to note:

    1/ In any other circumstances he would be lambasting Standard and Poors as ‘criminals who aided in the world economy’s collapse’ or such like

    2/ I happen to think the OBR version could be low – but what’s certain is whatever Murphy spends money on the multiplier effect will be low and in many cases so perverse is his understanding of incentives that the effect might even be negative.

    3/ Have never heard of his co-author but he looks like one to watch out for…..

  7. http://touchstoneblog.org.uk/2012/10/fiscal-multipliers-the-imf-the-obr/

    The multipliers as set out by the Office for Budget Responsibility (OBR) in June 2010 (paragraph C54 and table C8) were:

    Change in VAT: 0.35
    Change in personal tax and NICS: 0.3
    Change in welfare spend: 0.6
    Change in departmental spending: 0.6
    Change in capital spending: 1.0

    In other words, all roughly line in with the IMF’s 0.5. And that isn’t a surprise, as the primary source for the OBR’s own estimates was none other than the IMF. The OBR stated that its estimates were based on a range of empirical studies

  8. LizardKing

    Classic! How long will it stay there? – I’ll preserve it here where it won’t be deleted by a friendly stool pigeon:

    ‘ Excellent article. Should be required reading for every economics, social and political studies student and every aspiring politician. We live in a critical time facing combined ecological, economic, social and political melt downs. To prevent mass global poverty, resource depletion, irreversible global warming and major social unrest we must get to grips with alternative thinking that you advocate’

  9. Why not ask the Fiscal Multiplier himself.
    (Who is, I suspect a scruffy, smelly little man inhabits a couple rooms deep in the basements of the Treasury, where he sits fingering a well worn tarot deck)

  10. I wouldn’t have expected a relationship like this to be linear.

    Naively, if state spending is very low indeed, a small increase might go on something useful which would achieve a gain; otoh if state spending is very high (as in the USSR, or the DDR, or Scotland), then any additional is likely to go on vanity projects or simple class warfare, therefore probably leading to further impoverishment.

    But then ianae so what do I know?

  11. ken,

    The OBR source via that link puts the VAT rate change multiplier at 0.35. So if you raise an extra £1bn from VAT you reduce GDP by £350mn in the short.

    What happens if you cut VAT revenues by £1bn? The examples from Duncan Wheldon in your link suggest you again reduce GDP by £350m. The OBR has raising revenue reducing GDP by the multiplier while Wheldon has reducing revenue reducing GDP by the multiplier. Are both correct?

  12. In a moment that is a comedic non pareil, Ivan Horrocks, who vies with three other sycophants to be Murphy’s most assiduous bottom sniffer and licker, pops up to make another fawning post below that of the wonderful RW noted above!

    These people are academics, FFS, credited with the intelligence to have young minds entrusted to their wise teaching.

  13. BraveFart

    Horrocks sounds like he is waiting for time travel to become a reality so he can return to the 1950s – in fairness to him he does sound a little more personable than the appalling Carol Wilcox but it’s rather like discussing the virtue of the Primary defendants at Nuremberg – a purely academic exercise…

  14. Bloke in Costa Rica

    There’s a large category of public spending, including most of the things on Murphy’s wish-list, where the multiplier is negative. Spending £X on a diversity coordinator or on some fatuous twerp dreaming up ever-more onerous red tape will yield a reduction in wealth of -£kX. I don’t know what k is, but I suspect in some cases it is ≫ 1.

  15. Gareth

    If we cut VAT (which is equivalent to an increase in spending), there is an increase in GDP of 0.35 x the original VAT cut if we believe the OBR number. Weldon is saying that if we cut spending (which is the same as raising taxes) there is a reduction in economic activity. So the two are not in contradiction.

    For those interested, we can see the OBR’s post mortem of their forecast here

    http://budgetresponsibility.org.uk/docs/dlm_uploads/Forecast_evaluation_report_2014_dn4H.pdf

    See page 24.

    Maybe fiscal multipliers are higher in this period, or maybe not.

  16. @Luis

    I presume Tim is taking issue with

    To put it more directly: the government and Office for Budget Responsibility assume every pound of government spending shrinks national income and, in reverse, every pound of cuts increases national income.

    Does that still sound about right to you?

  17. ken,

    Thanks for the reply. Sorry for being a bit thick but I’m still not clear.

    To me the OBR is saying a reduction in taxes increases GDP by the multiplier. Wheldon is saying a reduction in taxes *reduces* GDP by the multiplier. A multiplier other than 0.5 results in two different answers.

    eg if your multiplier is 1.5 then the OBR would expect a £10bn cut to create a £15bn increase, resulting in a £5bn overall increase in GDP. Wheldon on the other hand would expect a £10bn cut to lead to a £15bn decrease in GDP.

  18. “Where’s the other 40p gone? If you meant national income grows by an *additional* 60p then shouldn’t the multiplier be 1.6x?”

    With a multiplicar of 0.6, an aditional 1£ in government spending creates a reduction of 40p in private spending, with a total increase in the national income of 60p.

  19. Gareth

    The original OBR piece is about how the government is reducing the deficit. They raise VAT by £10 billion, which will result in a fall in GDP of £3.5 billion.

    If we were to lower taxes, the inverse would be true. The Wheldon piece is about cutting expenditures or raising taxes based as it is on the original OBR piece.

  20. further, sorry i should make clearer when I made initial comment i had not spotted Richard asserting OBR assume negative multiplier. He is wrong they did not such thing.

  21. @Luis

    Who knows, you might soon be teaching postgrad work to one of those lucky enough to have been his students. Bet that little thought cheers you up no end 🙂

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