Calculations re Unpleasant Arithmetic

Dani Rodrik has a post that’s relevant to all the discussion about the stimulus aka “bailout” money being spent:

Some unpleasant Keynesian arithmetic

How much of a boost to economic activity will a fiscal stimulus provide? For those who believe that we have entered a Keynesian world of shortage of
aggregate demand–me included–the answer depends on the Keynesian multiplier.  The size of this multiplier depends in turn on three things in
particular, the marginal propensity to consume (c), the marginal tax rate (t), and the marginal propensity to import (m).  If c=0.8, t=0.2, and m=0.2,
the Keynesian multiplier is 1.8 (=1/(1-c(1-t)+m)). A $1 trillion fiscal stimulus would increase GDP by $1.8 trillion.

Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8.  The same fiscal stimulus would now produce an increase in
GDP of $2.8 trillion–quite a difference. Nice deal if you can get it.

*In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of
income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8).  Yes, yes, import protection is inefficient and not a
very neighborly thing to do–but should we really care if the alternative is significantly lower growth and higher unemployment?  More to the point, will
Obama and his advisers care?*

The clear conclusion is that, to prevent free riding, their will need to be international co-operation to prevent backsliding into protectionism:

The way out of this dilemma is to get the rest of the world to engage in fiscal expansion at the same time–so that the gift is returned.  The good news here is that China is playing along and hopefully the Europeans will too (if they can convince Germans to get over their weird obsession with fiscal conservatism).

A first I’d thought, oh no, this is just similar to the classic prisoners dilemma: defect or cooperate. To defect is an evolutionary stable strategy, and so the chances of co-operation as we move forward should be pretty low. But this conclusion is flawed.  The classic prisoner’s dilemma’s essential conditions include a limit on informational flow between the players–if that breaks down, the whole game is different. (Recall how explicit informational states are in John von Neumann‘s The Theory of Games and Economic Behavior)  Clearly informational flows are anything but restricted as consensus is built for the various stimulus programs.

But still it’s worth noting that policy makers can increase the payback from a stimulus package by instituting import controls.

Follow-up, from the Financial  Times:

YES WE CAN!! have a global depression if we really continue to work at it…

February 1, 2009

I used to be optimistic about the capacity of our political leaders and central bankers to avoid the policy mistakes that could turn the current global recession into a deep and lasting global depression.  Now I’m not so sure.

I used to believe that the unavoidable protectionist and mercantilist rhetoric would not be matched by protectionist and mercantilist deeds.  Protectionism was one of the factors that turned a US financial crisis into a global depression in the 1930s. …

I used to believe that our fiscal policy makers would, when faced with a combination of national and global disaster, manage to come up with a set of national fiscal packages that would be modulated according to national fiscal spare capacity and that would be designed not only to boost domestic and global demand but also to eliminate or at any rate reduce the underlying global imbalances that are an important part of the story of this global crisis. ……

I used to believe that our central bankers would overcome their natural conservatism, caution and timidity to do what it takes to bring to bear the full measure of what the central bank can deliver on a disfunctional financial sector and on a depressed economy, at risk of deflation.  Now I’m not so sure.  While the Fed is turning on most of the taps (albeit in a unnecessary moral hazard-maximising way), the Bank of England and the ECB are falling further and further behind the curve.  What the Bank of Japan does, no-one fully understands, and I will observe a mystified, if not respectful silence.

The US is not alone in moving down the protectionist track.  Since the last G20 meeting (with its unanimously endorsed call to avoid protectionism), virtually all the emerging market member nations of the G20 have introduced or announced  protectionist measures.


In the UK, prime minister Gordon Brown is reaping the protectionist storm he sowed with his infamous protectionist and xenophobic call for “British jobs for British workers”.  What was he thinking?  Follow the logic: ‘British jobs for British workers’,’Scottish jobs for Scottish workers’ (along with ‘It’s Scotland’s oil’), ‘Welsh jobs for Welsh workers’ and ‘English jobs for English workers’.  Why not London jobs for London Workers, or London jobs for native-born London workers, or even London jobs for white Christian native-born London workers?

Calculations re Unpleasant Arithmetic

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