Even though Paul Krugman on many occasions has trashed Austrian Economics, nonetheless he is not afraid to take an a priori position on his “pet stimulus.” Unfortunately, he refers to “Okun’s Law” which really is no “law” at all, but rather a empirical proposition based upon government-created aggregates.
Furthermore, he that government spend even more money than Obama has proposed because “Okun’s Law” states that the more government spends, the better off the economy:
The starting point for this discussion is Okun’s Law, the relationship between changes in real GDP and changes in the unemployment rate. Estimates of the Okun’s Law coefficient range from 2 to 3. I’ll use 2, which is an optimistic estimate for current purposes: it says that you have to raise real GDP by 2 percent from what it would otherwise have been to reduce the unemployment rate 1 percentage point from what it would otherwise have been. Since GDP is roughly $15 trillion, this means that you have to raise GDP by $300 billion per year to reduce unemployment by 1 percentage point.
Now, what we’re hearing about the Obama plan is that it calls for $775 billion over two years, with $300 billion in tax cuts and the rest in spending. Call that $150 billion per year in tax cuts, $240 billion each year in spending.
How much do tax cuts and spending raise GDP? The widely cited estimates of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.
Unfortunately those Evil Republicans are trying to stop all of this goodness, according to Krugman:
And that gets us to politics. This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for -- and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan’s perceived failure, if it’s spun that way, will be placed on Democrats.
I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”
Of course, the entire “stimulus” is a fraud. Krugman is assuming that all government spending is good, and is even better when the economy is in the tank. (Keynesians believe that opportunity cost disappears when the unemployment rate gets above five percent.) But, hey, Krugman has the “law” on his side.
