Wednesday, June 24, 2009

Multipliers

In class today we talked about the differences in AD multipliers. In theory, the tax cut multiplier is less than the government expenditure multiplier. The empirical evidence is somewhat different. As part of their economic research, the San Francisco Fed published an Economic Letter on June 19th that look at the research into the size of the multipliers. The results are interesting.

Regarding the impact of tax cuts on the level of real GDP one year after the change in taxes, the three studies predict a multiplier of roughly 1.2, as shown in Table 1. Moreover, Table 2 shows that, in contrast to theoretical predictions from the simple Keynesian framework, the analyses found that government spending had less bang for the buck than tax cuts. For instance, one year after the increase in spending, the impact on the level of real GDP is less than one-for-one, partly reflecting a decline in investment.

What this says is that our model is at odds with the observed data and hence needs to be changed. It also says that from a policy perspective, tax cuts work better than spending increases.

HT: Sonoran Alliance

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