Earlier I mentioned that Paul Walker and myself had different ideas surrounding the need for a stimulus in the US. Fundamentally I think he is completely against while I see scope for some stimulus.
Over at Brad Delong’s blog he mentions a description of the stimulus by Kevin Murphy.
The structure he describes is below:
Evaluating the Fiscal Stimulus
Kevin M. Murphy
January 16, 2009
A Framework for Thinking about the Stimulus Package
- Let G = increase in government spending
- 1-α= value of a dollar of government spending (α measures the inefficiency of government)
- Let f equal the fraction of the output produced using “idle” resources
- Let λ be the relative value of “idle” resources
- Let d be the deadweight cost per dollar of revenue from the taxation required to pay for the spending
When Will the Stimulus Add Value?
- The net gain is the value of the output produced less the costs of the inputs and the deadweight loss
- In terms of the previous notation we have: Net Gain = (1-α)G –[(1-f)G + λfG] –dG
- Net gain = (f(1-λ) –α–d)G
- A positive net gain requires that: f(1-λ) > α+d
- Difference of opinion comes from different assumptions about f, λ, α, and d
So the values of f, λ, α, and d define the different value judgments we may hold – which in turn determines what we think is the “best” solution. My impression is that:
α= government inefficiency,
λ=reservation value of unemployed resources (the opportunity cost from getting these people into work),
d=deadweight loss from taxation,
f=a “multiplier” on the net value created by the employment of idle resources.
As Brad says:
More interesting, I think, is that there is an unemployment rate at which Kevin Murphy’s priors would switch and he would become a stimulus advocate
Interesting. So given that we need f(1-λ) > α+d, I would place my priors from a small targeted stimulus in the US at present at f=1, λ=0.2, α=0.2, d=0.5 which is a slight net gain. Feel free to provide evidence to make me change my priors 😉