Professor's Murfhy's framework for the Stimulus Package
Let G = increase in government spending
1-α= value of a dollar of government spending (αmeasures 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
The new assumptions
- Government in general is inefficient
-The need to act quickly will make it more inefficient
-The desire to spend a lot in a short period of time will make it more inefficient
-Trying to be both stimulus and investment will make it even more inefficient
- 1-f likely to be positive and may be large.
- With a large fraction of resources employed(roughly 93%) much will
be drawn from other activities rather than “idle” resources .
- Ricardian equivalence implies that people will save to pay for future
taxes reducing private spending
- λ is non-zero and likely to be substantial
(People place positive value on their time,unemployed resources produce value through relocation e.g. mobility & job search)
- d is likely to be significant
(Wide range of estimates of d ,estimates based on taxable income)
With these parameters the stimulus package is likely to be a bad idea!
Αμετανόητοι Chicago boys....