On Monday, the Obama administration made a strong plea to Congress to “copper up” and pass a new set of spending measures to help dig the economy “out of a deep valley”. The call for action, by Lawrence Summers, Barack Obama’s senior economic adviser, urged Congress to pass up to $200bn (£138.9bn) in additional spending measures.
This is a further disappointment from the early days of the new administration. In the first days of government, Obama’s advisors firmly believed the US economy is like a Keynesian fruit machine. Input the stimulus, pull the lever, the wheels spin and the jackpot of growth, falling unemployment and stable prices can be achieved.
According to the Christine Romer, Chair of the Council of Economic advisors in the Obama administration, the arithmetic of recovery was pretty straight forward.
Romer along with Jared Bernstein was tasked with authoring the administration’s package to engineer recovery. It was a big package $775 billion, 5% of GDP over two years. Romer and Bernstein outlined how the plan would lead to an increase in GDP of 3.7% and an increase in jobs of 3.7 million.
The model was based on three critical numbers, 1 the size of the stimulus, 2, the impact on GDP growth, 3 the impact of GDP growth on unemployment. The key numbers are the "multiplier" and the "Okun co-efficient". The mechanics of the fruit machine. Who said economic modelling was difficult.
Romer and Bernstein use the Keynesian multipliers of 1.5 for government spending and less than 1 for tax cuts. Spending leads to growth, growth increases jobs. “The rule of thumb is that a 1 percent increase in GDP corresponds to an increase in employment of approximately 1 million jobs, or about three-quarters of a percent" they said. An Okun co-efficient of 1.33. Keynesian multipliers and Okun co-efficients, it all seemed so easy
Unfortunately, the pattern of unemployment moved off the map. Growth in the US is worse than expected. Tax cuts have led to an increase in savings ratio as household worry about employment, repair balance sheets and reduce debts. Government spending programmes, the “shovel ready” plans, take time to be effective.
So Congress is being asked to “copper up” again, the problem is there are few tokens left in the US Treasury. Romer and Bernstein have failed to hit the jack pot. Who said economic modelling was difficult, it is.
Romer and Bernstein: The Job impact of the American Recovery and Reinvestment Plan.
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