Thursday, October 1, 2009

Professor Delong Sets the Table for Multiplier Measurement

Professor DeLong explains how government spending should have essentially the same multiplier as housing construction spending:

"Shocks to spending boost nominal demand: whenever any significant group decides to boost their spending nominal demand rises, whether that group is new businesses seeking to profit from technological progress in high-tech in the 1990s, construction companies tht find they can obtain cheap financing via derivatives in 2004, or the U.S. government in 2009. The government's money is as good as anyone's." [emphasis added]

If he's right, then we could look at the effects of housing construction spending to learn about the controversial government spending multiplier. Furthermore, Professor DeLong explained to us (above) how the housing boom and bust are especially interesting autonomous spending changes (that is, changes well suited for measuring multipliers). So let's look:

During the boom, I see an obvious crowding out (as opposed to the "crowding in" claimed by Professor Krugman): more housing construction was reducing non-residential construction, not increasing it. Remember that the multiplier advocates claim that spending in one sector motivates spending in another.

During the early part of the bust -- though the end of 2008, and thus through 12 months of recession -- I also see a clear crowding out: less housing construction was increasing non-residential construction. That non-residential construction spending increase did not need a spending boom in the housing or any other sector to get going (Krugman's view) but rather needed LESS spending in other areas.

Even during 2009, it's difficult to see housing spending drops doing much to significantly pull down non-residential spending. To the degree that non-residential spending fell, it may be due to crowding out by public construction spending (not shown in the graph) ... when I get some numbers on this I'll let you know.


Greg said...

After carefully reading Brad Delong's website for many years now, I feel well equipped to respond exactly as he would:

"We need lots more spending and Keynes is right. Here's why:

1) To begin, the University of Chicago is evil.

2) SAY'S LAW!!!!!

3) Insert 40 pages of talking in circles.

4) SAY'S LAW!!!!!

5) Bigger government is better as long and the Democrats can do no wrong.

6) SAY'S LAW!!!!!

7) Robert Barro, Eugene Fama, Bob Lucas, John Cochrane, and John Taylor are all idiots. Only Paul Krugman and I know anything about economics.

8) SAY'S LAW!!!!!

9) Andrei Schleifer was my roommate!"

Sheng said...

I once wrote a small investment analysis piece at the end of 2008 arguing that, based upon the prospect of public projects spending, the construction equipment manufacturing companies should have good potential to bounce up. I cited some numbers saying the public investment expenditure is increasing. I sent it to an investment club supervisor, and -- got rejected. See, these real-world investors don't really count government expenditure! Early this year I went to browse one of those manufacturers' financial reports, it didn't spare a word to mention the outlook based on government stimulus plan. Bad economics only blind economists themselves, not the real world.

Another number coming up today is the auto sale for Sep. Without the clunkers program, it's in crash again...

Boonton said...

During the boom, I see an obvious crowding out (as opposed to the "crowding in" claimed by Professor Krugman): more housing construction was reducing non-residential construction, not increasing it. Remember that the multiplier advocates claim that spending in one sector motivates spending in another.

You see nothing of the sort. You see a boom in residential construction and relative stability (maybe a slight decline) in non-residential construction. So what? Out of all the industries for the multiplier to operate why would it hit non-residential construction? Here's a few reasons why this is the *worst* place to seek out the multiplier:

1. Supply - Those supplying residential construction probably have a lot of overlap with those supplying non-residential construction. A boom in the first means a tighter supply on the latter.

2. Spending - Think about this carefully-a boom in residential construction means income for those in that business. Why would you assume those in this business would spend their additional income on building office buildings? While I'm sure home construction companies did build offices and showrooms during the bubble, this is probably a trivial amount of non-residential construction which includes retail establishments like malls and commerical office buildings, factories etc.

3. Spending 2 - Where would booming income for labor and business owners involved in residential construction go? All over. Equipment, banks, Wal-Mart, Starbucks, Pickup trucks, bars, beer, movies, etc. The multiplier would boost the entire economy. why would you look at only one sector rather than the entire economy?

4. Housing bubble not construction bubble! - The bubble was in housing spending. A lot of that was new developments but a lot more was in existing housing. This meant the bulk of this 'natural stimulus' happened in the form of income to real estate agents, capital gains to homeowners who cashed out during the boom, financial institutions providing the services behind the scenes etc.

5. If you say "crowd out" you've already lost the anti-stimulus argument. What does classical Keynesian theory say will happen if an economy at full employment tries to stimulate itself? Because the economy is at full employment the stimulus can only come by crowding something else out. Hence Barro's 'finding' that consumer spending fell during the WWII 'stimulus'. Yes because the gov't was buying tanks consumers were not allowed to buy cars because back then the US economy only had capacity to supply one but not the other. If you assert crowding out as an argument against any stimulus your only intellectually viable option is to assert that the economy is always at full employment.

Sheng said...

That's interesting: whenever you see crowd-out you would argue that the economy is at the full employment; whenever you see crow-in, you would argue that the economy is not at the full employment, hence the stimulus is in work.

So here is the question: between 2001-2006 the economy is not at the full employment (so that you have the crowd-in/multiplier effects)? Is or not?

According to what underlies your reasoning, it seems you think the construction industry is in full employment while others are not, that's why you see multiplier effects in other sectors but not in construction sector. So what does the employment number in construction sector say about this before the crisis? More people in or out?

Boonton said...


I'm not sure I'm following this. Whether or not the construction industry was at full employment or not is not something we can tell from the graph (try to tell me what was the unemployment rate for construction workers in the graph?)

I think the 'crowd out' effect in the graph has nothing to do with stimulus but the fact construction can sell to two types of customers; residential and non-residential. During the boom construction firms found more jobs building houses than doctors offices or shopping malls. That's all. Its no different than a bunch of visiting Irishmen hitting a bar one evening and guzzling down lots of Guiness. If the owner graphed sales he would notice that night Bud sales fell while Guiness sales spiked. In a sense there was 'crowd out' because the bar tender spent his time pouring one type of beer rather than the other.

The only thing the graph can tell us is that during the 00's more money was made building residential homes than non-residential buildings and that reversed after 2008. There is nothing the graph can tell us about whether or not stimulus works or what the multiplier is if it does.