Keynes, fruit machines and the US recovery package, implications for the UK

Keynes led us to believe the economy is like a fruit machine. Input the stimulus, pull the lever, the wheels spin and the jackpot of growth, falling unemployment and stable prices can be achieved.

Furthermore, models of the economy and the econometrics within are now so sophisticated, given a set target for growth and jobs, the required stimulus can easily be estimated. According to the Christine Romer, Chair of the Council of Economic advisors in the Obama administration, the arithmetic of recovery is pretty straight forward, or so we were led to believe.

Romer along with Jared Bernstein was tasked with authoring the administration’s package to recover from the recession of 2008/9. It was a big package around $775 billion approximately 5% of GDP over two years. But no need to worry, Romer and Bernstein outlined how the plan would lead to an increase in GDP of 3.7% and an increase in jobs of 3.7 million. They even published the chart of how unemployment rates would out turn, with or without the stimulus.

The model was based on three critical numbers, firstly the size of the stimulus, secondly, the extent to which the stimulus impacts on GDP growth, finally the extent to which the GDP growth leads to a reduction in unemployment. The key numbers are the multiplier and the Okun co-efficient. The mechanics of the fruit machine. Who said economic modelling was difficult.

Romer and Bernstein use the Keynesian multipliers of 1.5 for government spending and less than 1 for tax cuts. Spending leads to growth, growth increases jobs. “The rule of thumb is that a 1 percent increase in GDP corresponds to an increase in employment of approximately 1 million jobs, or about three-quarters of a percent".  An Okun co-efficient of 1.33. Keynesian multipliers and Okun co-efficients, it all seemed so easy

Unfortunately, the pattern of unemployment is moving off the map. The reality in the US  is far worse than expected, with or without the stimulus. The tax cuts have led to an increase in the savings ratio as household worry about jobs, repair balance sheets and reduce debts. Government spending programmes, the “shovel ready” plans, take time to be effective. Keynes taught that savings equals investment but investment is falling, savings are rising, rates have been falling. What news of the IS-LM model. Who said economic modelling was difficult, it is.

In the US the call is already for a second stimulus package but others caution on debt levels and the delayed impact of the initial spin off the wheels. In the UK, the government has no other option but to wait and see. There are no tokens left in the Treasury for the slot machine.

Romer and Bernstein: The Job impact of the American Recovery and Reinvestment Plan.

January Could the American recovery plan work in the UK

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Comments

[Fruit Machines]

interesting analagy

[osteoporosis exercise]

They even published the chart of how unemployment rates would out turn, with or without the stimulus.

[victor]

Interesting... though I'd be scared if the economy was indeed like a fruitmachine. i wouldn't want think that we can leave everything all up to fate, cross our fingers and wish for the better.