IN WHICH I EXPLAIN ECONOMICS TO GREG MANKIW.

Greg Mankiw is a widely well-regarded economist, and I am neither well regarded nor an economist, but he seems to be willfully misunderstanding the new administration's stimulus plans in order to make a snarky point:

"Facing an increasingly ominous economic outlook, President-elect Barack Obama and other Democrats are rapidly ratcheting up plans for a massive fiscal stimulus program that could total as much as $700 billion over the next two years. ... Obama has set a goal of creating or preserving 2.5 million jobs by 2011."

Dividing one number by the other, that works out to $280,000 per job.

What is going on here? Logically, it must be one of three possibilities:

1. The fiscal stimulus is going to be much smaller than is being reported.
2. The new administration is setting a low bar for itself when it comes to job creation.
3. The Obama team believes in very small fiscal policy multipliers.

Let me amplify the last point with a rough back-of-the-envelope calculation. The average weekly earnings of production and nonsupervisory workers is about $600, or about $60,000 over a two-year period. Granted, labor income is only about two-thirds of national income, and we have to add a few supervisors into the mix. So let's say each job created means $100,000 of extra national income. If we are generating $100,000 of income with $280,000 of government spending, the multiplier is only 100/280, or 0.36. By contrast, traditional Keynesian models suggest a multiplier closer to 2.0.

Or it could mean that not all of the stimulus package is focused directly on job creation. Which, in fact, it likely will not be, since most economists I've spoken to and many reports I've read predict that a big chunk of the stimulus -- tens of billions of dollars -- will include increased funding for things like food stamps, TANF, and unemployment insurance. It will likely also include federal aid to states, much of which will be used to make up massive budget shortfalls on programs like medicaidare. While that aid doesn't directly create jobs, without it, states would have been firing public employees to balance their budgets, especially with the bond market as tight as it is.

None of those facets of the stimulus program directly create jobs, but they ease the pain for the millions of people losing jobs, preventing them from falling into deep poverty while the economy returns to course, and stimulate the economy in the aggregate. Subtracting the cost of these kinds of aid from the total cost of the stimulus will probably make the cost-per-job figure seem more reasonable.

On another note, Mankiw says that the fiscal policy multipliers are too small -- that is, I presume, the assumed effects of each stimulus dollar in relation to economic growth don't seem worthwhile. Presumably he knows this better than I, but I'm confused because of this chart which has appeared in various forms in most discussions of future stimulus packages. It purports to tell us the economic benefit for each dollar spent through various economic policy mechanisms. The largest multiplier it offers is .58, for increasing food stamps; nothing approaches the 2.0 multiplier that Mankiw suggests is appropriate. Either Mankiw is talking about something different from what Mark Zandi, the creator of the chart, is trying to explain, and I just don't get it, or one of them is wrong about what kind of fiscal policy multipliers we should expect from the stimulus. I'll look into it.

--Tim Fernholz

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