## Wednesday, November 12, 2008

### Krugman's Stimulus Math: \$600 Billion

Interesting post from Paul Krugman about how large an upcoming U.S. stimulus package should be. Lets see if I can't make his already easy to understand post even clearer for those that prefer a visual format:

First, Paul determines the likely employment gap (the difference between the natural rate of unemployment and the likely unemployment we will see when this cycle bottoms). Using 5% as the natural rate of unemployment and an 8.5% unemployment rate (a Goldman Sachs estimate... I personally think it will be higher), we get a 3.5% employment gap. According to Okun's Law:

For every 1% excess of the natural unemployment rate, a 2%reduction in GDP is predicted. The difference between actual and potential GDP is called the GDP (or output) gap.

So if we take 3.5% and multiply by 2, we come up with a 7% output gap in GDP. To close this gap, we need a stimulus package that adds this 7% back to the economy. Considering the poor result of the first stimulus package, Paul assigns a multiplier of 2 to any package (the stimulus isn't spent once, it is spent multiple times as it works its ways through our consumer economy). With this 2x multiplier, the stimulus package should be 7% / 2 = 3.5%, which he rounds up to 4% be on the safe side or ~\$600 Billion.

How big could a package get? Looking at only two variables, unemployment and the multiplier, we can see how the size of a package moves in response to any change. Moving the unemployment out to 9.5% (massive, but not altogether impossible) and the multiplier down to 1 (if unemployment is 9.5%, will people really be spending their checks?), the "required" package more than doubles to \$1.4 Trillion or about 10% of our GDP. Still significantly lower than China's (as a percent of GDP) which was almost 20% of their GDP.

#### 2 comments:

1. interesting however I don't believe Krugman's estimate includes the NEGATIVE GDP effect of tall the outstanding debt in consumers hands. Because that debt is now accumulating even more penalties it takes MORE consumer spending to overcome it.

SO any stimulus either has to STOP the monthly cost of consumer debt or at least freeze it at pre crisis amounts to even get us back to the level of consumer spending that was happening before the stimulus.

the huge amount of consumer debt simple must be either eliminated or inflated to nothing or we will stay in depression like third world countries in debt to the IMF who NEVER get out of debt and NEVER recover.

We are in afar worse situation than in the great depression. Int he great depression people didn't have debt - they just didn't have income to spend. Now people don't have income to spend AND they have huge amounts of impossible increasing usurious interest rated debt as well.

2. Ideas being mooted for how to spend the stimulus - such as infrastructure spending and increased unemployment benefits - have multipliers closer to 2 than to 1.