San Fran Fed Finds Problem with Econometric Multipliers

Despite the obvious bias which engulfs the incestual working relationship between the Federal Reserve System, the U.S. financial sector, and the U.S. government, occasionally some grains of truth trickle out from these Ministries of Truth.  In a new report by Daniel J. Wilson out of the Federal Reserve Bank of San Francisco, it turns out that fiscal stimulus, get this, might actually vary in effect upon implementation and thus the multiplier effect!

The severe global economic downturn and the large stimulus programs that governments in many countries adopted in response have generated a resurgence in research on the effects of fiscal policy. One key lesson emerging from this research is that there is no single fiscal multiplier that sums up the economic impact of fiscal policy. Rather, the impact varies widely depending on the specific fiscal policies put into effect and the overall economic environment.

With this kind of groundbreaking research being produced by PhD’d economists operating as fellows or researchers at Fed banks, what other explanations or theories could we possibly need?  The serious question still remains on how is this a new discovery?  Money doesn’t transverse through millions of economic hands in a predictable fashion.  The idea that economists aided by mathematical formulas and supercomputers are able to foresee how market actors will proceed in spending funds confiscated and given away by the political class is afflicted with conceit.  Human action can’t be observed as a constant such as in the physical sciences.  Murray Rothbard explains in The Mantle of Science:

Finally such staples of mathematical economics as the calculus are completely inappropriate for human action because they assume infinitely small continuity; while such concepts may legitimately describe the completely determined path of a physical particle, they are seriously misleading in describing the willed action of a human being. Such willed action can occur only in discrete, non-infinitely-small steps, steps large enough to be perceivable by a human consciousness. Hence the continuity assumptions of calculus are inappropriate for the study of man.

This, of course, doesn’t stop some economists from presuming the infallibility of their formulas.  It’s already well known that President Obama’s first stimulus package, put into effect in early 2009, did not meet its goal of keeping unemployment below 9%.  The standard response from Keynesian proponents of fiscal stimulus to counter a cyclical downturn was that “the government didn’t spend enough.”  That is, it didn’t spend enough to jump start the fiscal multiplier and get those animal spirits shopping.

But as Wilson reveals, the alleged fiscal multiplier is hardly ever accurate:

What does this literature tell policymakers and others trying to assess the impact of fiscal policy changes? It is an inconvenient reality that this literature provides an enormous range of multiplier estimates, ranging from –1 to 3. However, this range is not so much a reflection of disagreement over an underlying parameter as it is a reflection of one of the key lessons of this research—that there is no single multiplier that can be applied mechanically to all situations. The impact depends on the type of fiscal policy changes in question and the environment in which they are implemented.

The sphere of human action is ever changing; of course there can be no one true multiplier.  With fiscal stimulus acting as the equivalent of a dart board for bureaucrats and economic mathematicians to calculate a multiplier, is it any wonder that grand promises of free lunches are never delivered upon with the enactment of a large increase in government expenditure?

As Frank Shostack shows (channeling Say’s Law), the free lunch doesn’t exist and any “extra” spending generated by fiscal stimulus backed by multipliers must come at the expense of future or existing production:

In the Keynesian multiplier story the initial consumer expenditure creates new income for the next person, who in turn creates income for another person and so on. However, to have income for consumption one must first produce something useful that can be exchanged in the market.

Through the production of goods an individual can secure the produced goods of other individuals in an economy. His production backs up, so to speak, his demand for the goods he wants to secure. For instance Bob the farmer secures one loaf of bread from John the baker by paying for the loaf of bread with five tomatoes. Bob also secures a pair of shoes from Paul the shoemaker by paying for the shoes with ten tomatoes.

Let us examine the effect of an increase in the government’s demand on an economy’s overall output. In an economy, which comprises of a baker, a shoemaker and a tomato grower, another individual enters the scene. This individual is an enforcer who is exercising his demand for goods by means of force.

Can such demand give rise to more output? On the contrary, it will impoverish the producers. The baker, the shoemaker, and the farmer will be forced to part with their product in an exchange for nothing and this in turn will weaken the flow of production of final consumer goods. Again, as one can see, not only does the increase in government outlays not raise overall output by a positive multiple, but on the contrary this leads to the weakening in the process of wealth generation in general.

Rather than justifying the multiplier effect, Wilson’s report is demonstrative of the kind of muddled thinking and practice behind such a concept.  There can never be a true multiplier just as there can never be a perfectly static economy.  The process of the market is dictated by human action outside the bounds of predictive mathematics.  You don’t need to peruse a bunch of time studies to figure out what should be common sense.

Just don’t expect this truth to stop the countless retorts of “we didn’t spend enough.”

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One Response to “San Fran Fed Finds Problem with Econometric Multipliers”

  1. Steven says:

    Nice one James! I liked the Mr. Shostack example. He's quite good! The central bankers are very, very slowly starting to learn that government (or them) doesn't create wealth. There is no magic wand. However, I don't know if they'll ever learn or admit the whole truth as it would undermine their existence…

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