Are Government Spending Multipliers Greater During Periods of Slack?
According to Keynesian economic theory, many recessions have little or nothing to do with underlying (structural) economic problems. Instead, recessions are the result of a crisis in confidence. People are scared and therefore not spending. And when they are not spending, others are not earning income and so the economy suffers.
Keynesian economists argue the government can cure this crisis in confidence by borrowing (deficit spending) to fund an increase in government purchases. And this spending has a multiplier effect, rippling throughout the economy.
Is it true the government purchases multiplier is larger during recessions? This paper by Michael Owyang (St. Louis Fed), Sarah Zubairy (Bank of Canada) and Valerie Ramey (UCSD) examines this question. They write:
A key question that has arisen during recent debates is whether government spending multipliers are larger during times when resources are idle. This paper seeks to shed light on this question by analyzing new quarterly historical data covering multiple large wars and depressions in the U.S. and Canada. Using an extension of Ramey’s (2011) military news series and Jordà’s (2005) method for estimating impulse responses, we find no evidence that multipliers are greater during periods of high unemployment in the U.S. In every case, the estimated multipliers are below unity.