Impact of the Government Shutdown

Welcome to my blog.  Today (October 1, 2013) the USA government has shutdown due to a budget impasse.  For me the key question is what will be the economic impact?  The economic impact depends on something called the “fiscal multiplier.”   In simple terms the fiscal multiplier shows the total impact of federal spending on the economy.  Each dollar of government spending typically does not have just a single dollar of impact.

There are two beliefs.  One side believes the fiscal multiplier is greater than 1.  This side of debate states ideas like government workers use their salaries to buy food, housing and clothing in their communities.  This means that government workers by spending their paychecks indirectly cause employment to rise in the communities where they live.

The other side of the debate believes the fiscal multiplier is less than 1.  This side states ideas like new government programs stifle the economy by imposing all kinds of burdens.  For example, there are many stories in the news that Obama care will lead to the private sector cutting back on jobs because they cannot afford the health insurance mandated by the new law.

Why is knowing this number important?  Because if the multiplier is less than 1 the optimal situation is to reduce the size and scope of the government.  However, if the multiplier is much larger than 1 (say 3) then the optimal situation is to have a large amount of government spending.

In the 1990s Alan Blinder wrote a short article (http://www.jstor.org/stable/2950924) that stated most economists believe that the fiscal multiplier is greater than 1.  My personal belief is that the current (2013) fiscal multiplier is greater than 1, but only by a small amount.  Time will tell if this belief is right.

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