Today, Paul Krugman attempts to gauge the size of the stimulus needed using the exact same methodology I used a few weeks back to estimate the size of the stimulus necessary to keep us out of recession.

He uses Okun's law and a projection of unemployment rates to determine how much stimulus is necessary.  

Using his projections, Prof. Krugman thinks the stimulus package proposed by Obama will be too small.  

From his post:

Finally, compare this with the economic outlook. "Full employment" clearly means an unemployment rate near 5 — the CBO says 5.2 for the NAIRU, which seems high to me. Unemployment is currently about 7 percent, and heading much higher; Obama himself says that absent stimulus it could go into double digits. Suppose that we’re looking at an economy that, absent stimulus, would have an average unemployment rate of 9 percent over the next two years; this plan would cut that to 7.3 percent, which would be a help but could easily be spun by critics as a failure.

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."

Let’s hope I’ve got this wrong.

We should be very worried that this stimulus will not be large enough, and Obama will bear responsibility for a poorly performing economy.

Let us use use Prof. Krugman's numbers and figure out how much stimulus he thinks is necessary to drive the economy to full employment:

R$300B per unemployment point over 5.2%
9% max unemployment
Okun's law multiplier of 2
Stimulus Multiplier of 1


Since it takes $300 billion to reduce the unemployment rate by 1 percentage point

We can simply use a multiplier of $300B per unemployment point

4.8 * 300B = $1.448 Billion

Using Paul Krugman's numbers, we need a stimulus of about $1.5 trillion to get to full employment.

According to his numbers, we need about $1.2T of spending to get to full employment.  This falls right into my estimated necessary stimulus range of $1.0 to $1.6T

I am glad the issue of the size of the stimulus is finally being introduced to the discussion of the economy.  It is long overdue, and we as proud liberals need to have the numbers at our disposal to fight the right wing noise machine.  

Update:  Somehow my first update got lost.  Thanks to nagilaguy for pointing out math errors in the original post.  

Originally posted to mickslam on Tue Jan 06, 2009 at 02:33 PM PST.

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