It is one of those Victor Meldrew theories. In other words, it is easy to say: “I don’t believe it.”
Economic theory, at least some of it, says government spending does not lead to more growth in an economy. The theory says that households spot that the government is spending more, and say to themselves, “aye aye, tax will rise,” and start spending less as a result, which cancels out the effect of the government stimulus.
At least that is what the “Lucas Critique" developed by Robert Lucas, for which he won a Nobel Prize in 1995, says. Some go further and say Barack Obama caused the global financial meltdown. They say even though the US recession began before Obama was President, the US electorate anticipated his victory, and thus cut back on their expenditure.
So there you have it. The Multiplier from a fiscal stimulus is zero.
It is odd, because the IMF recently said that right now the multiplier is between 0.9 and 1.7.
The Lucas Critique is famous for its elegant maths. But just because something is elegant it does not mean it is right.
And if it is the case that as the government spends more, we spend less, explain this:
Gillian Tett pointed out in the ‘FT’ that US consumers seem to be varying their monthly spend around pay day far more often these days. She quoted the boss of one of the US’s largest food and drinks companies as saying: “Since 2007, spending patterns have become extremely volatile. More and more consumers appear to be living hand-to-mouth, buying goods only when their pay checks, food stamps or benefit money arrive. And this change has not simply occurred in the poorest areas: even middle-class districts are prone to these swings. Hence the need to study local pay and benefit cycles.” See: The cost of hand-to-mouth living
So if that is so, how can they at the same time be so willing to save more if governments start spending more?
© Investment & Business News 2013