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Likely economic impact of Obama’s fiscal stimulus

On Monday of this week the Congressional Budget Office (CBO) responded to a request from the Senate to break down the anticipated effects of the fiscal stimulus of 17 February, which was incorporated into the American Recovery and Reinvestment Act of 2009 (ARRA).

 

Although the CBO made their forecasts based on the majority view of a number of economists, their outlook was basically Keynesian in approach. They noted a significant effect in the short run on GDP but little effect in the long run.

 

In the short run the CBO said that “the macroeconomic effects of any economic stimulus program are very uncertain” largely because such a stimulus as this one are rarely attempted. They worked out a number of “multipliers” to judge the effect of a one-time increase in spending or reduction of taxes, of one dollar. Interestingly, they estimated that federal spending on goods and services of $1.00 in the second quarter of 2009 would raise GDP by $1.00 to $2.50 over several quarters, with most of the effect in the first two quarters and little effect beyond a year.

The fiscal stimulus will crowd out private investment in the long run

The fiscal stimulus will crowd out private investment in the long run

 

In the long run the economy produces close to its potential output on average and short-run stimulative policies can affect long-run output by influencing the stock of productive capital, the supply of labour and productivity. However, such effects would generally be smaller than the short-run impact of those policies on demand.

 

However, they assumed that although the stimulus would have positive macroeconomic effects in the long run, these same effects would actually reduce output slightly in the long run. This would be as a result of “crowding out”. Increased government spending and/or reduced revenues would result in more government debt being issued. To the extent that people hold their wealth in government bonds rather than in a form of savings which could be used to finance private investment, this would “crowd out” private investment. The CBO estimates that in the long run each dollar of additional debt crowds out about a third of a dollar’s work of private domestic capital – with the rest of the rise in debt being offset by increases in private saving and inflows of foreign capital.

 

In conclusion, the CBO estimates that the legislation implies an increase in GDP (relative to their baseline forecast) of between 1.4% and 3.8% by the fourth quarter of 2009; between 1.1% and 3.4% by the fourth quarter of 2010; between 0.4% and 1.2% by the fourth quarter of 2011 and declining amounts thereafter. But, beyond 2015, the fiscal stimulus is estimated to reduce GDP by between zero and 0.2%. They also estimate that the bill will create an additional 1.2 to 3.3 million jobs by the end of 2010.

 

 

 

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Posted in crowding out, Fiscal stimulus, GDP, Keynesian, Public Finances, US economy

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