I tried to satisfy myself with a comment in the "Abbreviated Pundit Round-Up," but I just can't get over this nonsense:
If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment. In this scenario, the added government spending is a good idea even if the bridge goes to nowhere, or if public employees are just filling useless holes. Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases.
What's the flaw? The theory (a simple Keynesian macroeconomic model) implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.
John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved -- but economists have not come up with explanations, such as incomplete information, for multipliers above one.
First, the spending multiplier for recessionary infrastructure spending is greater than one because unlike the leisure class, the rest of us don't have a lot of assets, so we cut back on our spending when we're un- or under-employed. If we're suddenly put to work by increased government expenditures, then we immediately turn around and spend our new incomes locally, generating even more economic activity. This isn't rocket surgery, people! It's just basic human behavior.
Second, war spending doesn't work as well because a lot of human and physical capital is getting blown up, plus soldiers overseas tend to spend their wages where they are. Paul Krugman has a slightly different take, but comes to the same conclusion about Barro's "argument":
Actually, I’ve already taken that one on. But just to say it again: there was a war on. Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort.
Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone?
I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to estimate the multiplier that might prevail in an underemployed, rationing-free economy.
Third, we already know why the demand gap can't be fixed by monetary policy right now: it's up against the zero lower bound. Goldman Sachs (h/t Krugman) recently calculated that the usual rule of thumb would recommend a Fed funds rate of negative six, which is clearly impossible.
Finally, while "one might ask" why stop at only a trillion dollars of additional purchases, that hypothetical inquirer -- oh not Barro, he isn't actually saying that he would ask that, not at all! -- would have to have very carefully avoided ever encountering the concept of "diminishing returns." As more un- and under-employed are put to better use (such that fewer remain), the multiplier would diminish. Therefore, there must come a point -- perhaps at half a trillion, or one trillion, or two trillion, or something -- where it would no longer be worth spending more. Because it would've worked.
And the crazy thing? Barro is supposedly an economics professor at Harvard University. [boggle]