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'The Multiplier is at Least Two'

by ARGeezer Thu Nov 29th, 2012 at 05:38:35 AM EST

From The Federal Reserve Bank of San Francisco Economic Letter #2012-35 of November 26, 2012:

(Cascading Hat Tips to Migeru Shimbun and Economist's View)

Highway Grants: Roads to Prosperity?

By Sylvain Leduc and Daniel Wilson

Federal highway grants to states appear to boost economic activity in the short and medium term. The short-term effects appear to be due largely to increases in aggregate demand. Medium-term effects apparently reflect the increased productive capacity brought by improved roads. Overall, each dollar of federal highway grants received by a state raises that state's annual economic output by at least two dollars, a relatively large multiplier.

Increasing government spending during periods of economic weakness to offset slower private-sector spending has long been an important policy tool. In particular, during the recent recession and slow recovery, federal officials put in place fiscal measures, including increased government spending, to boost economic growth and lower unemployment. One form of government spending that has received a lot of attention is public investment in infrastructure projects. The 2009 American Recovery and Reinvestment Act (ARRA) allocated $40 billion to the Department of Transportation for spending on the nation's roads and other public infrastructure. Such public infrastructure investment harks back to the Great Depression, when programs such as the Works Progress Administration and the Tennessee Valley Authority were inaugurated.

One criticism of public infrastructure programs is that they take a long time to put in place and therefore are unlikely to be effective quickly enough to alleviate economic downturns. The fact is, though, that surprisingly little empirical information is available about the effect of public infrastructure investment on economic activity over the short and medium term.

This Economic Letter examines new research (Leduc and Wilson, forthcoming) on the dynamic effects of public investment in roads and highways on gross state product (GSP), the total economic output of a state. This research focuses on investment in roads and highways in part because it is the largest component of public infrastructure in the United States. Moreover, the procedures by which federal highway grants are distributed to states help us identify more precisely how transportation spending affects economic activity.

We find that unanticipated increases in highway spending have positive but temporary effects on GSP, both in the short and medium run. The short-run effect is consistent with a traditional Keynesian channel in which output increases because of a rise in aggregate demand, combined with slow-to-adjust prices. In contrast, the positive response of GSP over the medium run is in line with a supply-side effect due to an increase in the economy's productive capacity.

We also assess how much bang each additional buck of highway spending creates by calculating the multiplier, that is, the magnitude of the effect of each dollar of infrastructure spending on economic activity. We find that the multiplier is at least two. In other words, for each dollar of federal highway grants received by a state, that state's GSP rises by at least two dollars.

The methodology they employ and the reasoning behind it is of note:
We study forecast revisions rather than changes in actual highway spending for two reasons. First, actual spending may both affect and be affected by current economic conditions, making it difficult to sort out the true causal effects of the spending.

Second, changes in actual spending are most likely to be anticipated years in advance. For that reason, some of their economic effects may be felt before the spending changes actually take place. For instance, a state government and other important players, such as construction and engineering firms, may decide to spend more today if they expect the state to receive more highway grants in the future. In this way, changes in expectations regarding future grants to the states may be important for current economic activity. Failing to account for changes in expectations may lead to incorrect conclusions about how government spending affects economic activity (see Ramey 2011a).

Figure 1

Average response of state GDPs to unexpected grants

In our analysis of how changes in forecasts of highway grants to the states affect state GSP, we control for lags in state GSP, lags in receipt of highway grants, average state GSP levels, and national movements of gross domestic product (GDP) over the sample period from 1990 to 2010.

In Figure 1, the solid line shows the average percentage change in a state's GSP following a 1% increase in forecasted future highway grants to the states. The shaded area around the line represents a 90% probability range. The horizontal axis indicates the number of years after the unanticipated change in forecasted highway grants to the states. The figure shows that changes in the forecasts have a significant short-term effect on state output in the first one to two years. This effect fades, but then increases sharply six to eight years after the forecast revisions, before declining again. This pattern holds up well with alternative estimation techniques, the inclusion of different control variables, and with different data samples.

The forthcoming formal paper will undoubtedly employ much more mathematics and statistics and likely be suitably less readable by mere mortals.


Spending on wind power generation, associated distribution and on upgraded, electrified rail transport powered by same should have a multiplier of at least three.

My argument for a multiplier of three for wind power related energy and transport infrastructure is that energy costs are a fundamental part of all economic activity, that wind power, due to the Merit Order Effect, tends to cap the cost of peak power and thereby reduce the overall cost of power, and that the cost of energy is like a tax in its effect on economic activity.

Providing the maximum feasible amount of wind power and supplementing wind with solar and other renewable energy sources that have no fuel cost has a more beneficial effect than providing a similar amount of tax relief, in that, RW propaganda to the contrary, taxes do provide many benefits to a country, ranging from insuring the value and acceptability of its currency to, if properly applied, providing an equitable division of wealth within society. And this is all in addition to the benefits from reduced greenhouse gas emissions.

In my view the proper term over which to calculate the multiplier from such investments is the useful life of the asset. I believe the multiplier would be at least 3 even excluding avoided costs from the impacts of global warming, but including the expected increased costs of fossil fuels. More informed opinions may vary.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Nov 28th, 2012 at 01:54:25 PM EST
Of course the other 'tax-like' economic activity rampant in our societies today is speculative finance. I have seen estimates that up to 30% of the cost of almost everything we do goes to the financial sector. That is in line with the disproportionate share of profits flowing to the financial sector.  Beyond allocating capital to productive investments, which, in my generous opinion, constitutes at most 10%, probably more like 4% of economic activity, this is pure rent extraction. It is enabled by the de facto capture of our governments by the financial sector, which is, in turn, acting as the agents of the largest wealth holders in our societies.

A liveable world is possible, but not without reining in the financial sector, changing the role of money and wealth in politics and beginning to pursue policies designed for the benefit of the entire society and not just the top one or two percent of wealth holders. A start in that direction would be for governments to directly fund, without even issuing bonds, the construction of needed infrastructure. Just make the key strokes at the Treasury and the Fed to fund these activities.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Nov 28th, 2012 at 02:18:11 PM EST
How important is the multiplier? If the government has no real lack of money, the multiplier making certain spending more efficient in terms of economic activity/spending is not that important is it?

Of course in the current paradigm the multiplier is a great argument against austerity as austerity fails to produce its intended goals. So there is a rethorical use, but should it in a saner world be of importance?

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by A swedish kind of death on Thu Nov 29th, 2012 at 08:22:23 AM EST

You can take the number of un- and underemployed and multiply by the productivity per man-year to get the output gap. You then divide by the multiplier to get a rough idea about how much money you need to helicopter dump into the economy to make that output gap go away.

It's a crude heuristic based on a crass-Keynesian analysis, but it has the virtue of being relatively simple and straightforward. You shouldn't rely on it to fine-tune your fiscal program, but it will tell you if you're over- or undershooting by more than an order of magnitude.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Nov 29th, 2012 at 09:36:47 AM EST
[ Parent ]
Ok, but then the multiplier is a useful tool not a deciding factor. So there is no reason to go for an activity with higher multiplier (like say wind over gas in France or gas over wind in Britain) on the basis of the multiplier (unless you are negotiating with people who believe the government to be constrained in its use of the printing press).

If the government concludes activity A with multiplier 2 being more worthwhile then activity B with multiplier 3 it just gets another (higher) figure for the helicopter dump operation.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Thu Nov 29th, 2012 at 10:21:56 AM EST
[ Parent ]
Yes, but the composition of the demand leakages that cause the multiplier matters. If you get a lower multiplier because more of your added demand leaks to the foreign sector or into useless financial shenanigans, then that is an argument for going with the high-multiplier solution. Whereas if you get a lower multiplier because more demand leaks into paying down mortgage debts, then you may well prefer that solution.

The multiplier is a quick-and-dirty sanity check. Such checks have a good deal of value, but they should not be the deciding factor in determining policy.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Nov 29th, 2012 at 10:34:08 AM EST
[ Parent ]
There is also the point that if the multiplier is less than unity, you are either crowding out private expenditure or performing your cash injection in such a manner that most of it ends up offshore or in mattresses (i.e. using tax cuts rather than direct expenditure).

Either way, you're doing something you shouldn't be doing.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Nov 29th, 2012 at 03:17:59 PM EST
[ Parent ]
If we can find evidence for the differential impact on state economic activity of various expenditures at the federal level it provides another basis on which to decide on what the money should be spent. At a minimum the multiplier should be one, as someone who is unemployed is highly likely to spend all they earn, and, taken together, that spending should support one other person at the same income level.

It has long been known that government, construction and manufacturing jobs, which typically pay significantly more than the minimum, can provide the additional local spending to support retail, transport and service jobs. Construction jobs are typically paid from loan proceeds. State and local government are paid from state and local taxes. But, from a state and local perspective, manufacturing jobs are more like jobs producing for export. They bring money to the local economy from the larger world.

But government spending to create manufacturing jobs is the more problematic than for service and infrastructure. It is one thing to rescue the automobile industry, which had a long history of profitabile operation and a known market, but there would be fierce opposition to the government choosing a particular kind of manufacturing in which to invest, and Solyndra is a case in point. It looked like a winner in 2009 but is now bankrupt after having received >$500 billion in government loan guarantees. The market changed. So that leaves infrastructure.

Well, of course there is military spending, always popular with RW types. But, as the purpose of manufacturing for military purposes is to blow things up and as that product is 'consumed' by hapless Pakistani and Afghani villiagers, it doesn't produce much knock-on employment, especially as we ignore the need for prosthetics, etc for foreign nationals who were the recipients of that 'spending'. So military Keynesianism has a low multiplier, probably less than 1.5 - roughly one additional person for every two military people employed.

The condition of infrastructure in the USA is abysmal. We don't know which bridge will collapse next but, at currently budgeted replacement rates, more collapses are likely. Here in Arkansas a 20 mile section of Interstate 40, a major trucking route, floods in wet years and needs to be rebuilt. asdf posted a link about the need for improvements to electrical distribution, highlighted by the problems left in the wake of Superstorm Sandy.

So it is a good thing if you know that you will get the equivalent of over two people employed by spending on highway infrastructure, even if that turns out to be one person with a higher wage. Those are the kinds of jobs that support local economies, including dentists. It would be even better if we knew that, by building renewable based power generation and distribution and upgraded, electrified rail infrastructure we would be creating the equivalent of two additional jobs for every direct job created.

And, if/when that created inflation, raise taxes on the wealthy and impose luxury taxes. We would be putting the country on a path to economic and environmental sustainability while creating prosperity and greater equality. But we could also slow down that process and spend more on other areas of need with lower multipliers. It would be nice to have that choice.

The losers would be the rent extractors in the fossil fuel industry, but even that would not really be a hardship, as their reserves will only be increasing in value with time. They are more valuable as feed stocks for the petrochemical industry, etc. than as fuel for vehicles.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Nov 29th, 2012 at 11:36:56 AM EST
[ Parent ]
"If we can find evidence..."

I wonder if economics is on the cusp now of being able to do a complete analysis of national economic activity. A few tens of millions of person records is not that big of a database in modern computing terms. Companies like Acxiom have records of a pretty large fraction of financial transactions. Social media tracks and records what people are thinking.

You could do experiments pretty easily: Put up an ad on Facebook, see how many people view it, see how many people talk about it, see if they act on it by buying something, observe the incremental result in the overall economy. Repeat for a few billion transactions...

by asdf on Thu Nov 29th, 2012 at 11:49:38 AM EST
[ Parent ]
Steve Keen is starting to do just that! See
Energy, Production and Entropy.

He is working on:

  • a double entry bookkeeping model of economic flows

  • integrated with a physical 'single sector' model of the economy.

This is to show the possibilities. Steve's undergraduate work was in electrical engineering and, in other modeling work, he has created multi-sectoral models of the economy with a private sector, a manufacturing sector and a banking sector, all using differential equations and explicitly including time and money. The results of computer runs of some of those still crude models gave outputs remarkably like real world performance. Exciting stuff.  

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Nov 29th, 2012 at 12:14:32 PM EST
[ Parent ]
Keen seems to frequently over-reach himself. It's nice that he rates his own ability so highly, and all that blog-adulation must be terribly unhealthly.

He's just not a particularly good analyst.

by LondonAnalytics (Andrew Smith) on Sat Dec 1st, 2012 at 06:59:25 AM EST
[ Parent ]
Yes, he has the self confidence to strike out in new directions and he sometimes makes missteps. His first efforts in multi-sectoral modeling did not fully conform to double entry bookkeeping standards, this was noted and he has since responded. But 'mainstream economics' is not nearly so renowned for the quality of its analysis as it is for the ferocity of its imposition of discipline on any who stray from orthodoxy, especially if they question or challenge fundamental concepts, as Keen has done.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Dec 1st, 2012 at 12:12:01 PM EST
[ Parent ]

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