Barack Obama wants a substantial amount of stimulus right now. Really, everybody wants lots of stimulus except for the Neo-Hooverite Republicans. While there have been some estimates, not enough thought has been given to this topic. I am going to approach this from the perspective that the housing bubble, while bad, sustained the economy and we need to replace at least this much money in the economy to make the stimulus work.
So how much money do we need to spend?
How much money needs to be spent to get the economy back on track? Well, there is a simple "law" called Okun's law. The actual forumula is a little complex but there is a simplification that is very easy to understand.
From Wikipedia:
...unemployment above the inflation-threshold unemployment rate reduces GDP below potential output, and for every 1% excess of the natural unemployment rate, a 2% to 3% reduction in GDP is predicted.
Pretty simple, and straight forward, we need stimulus equal to that amount to get us back on track. The general consensus is that the multiplier is closer to 2 in recent years.
Of course, some economists will talk about multipliers of the different kinds of stimulus, and these are important too. These multipliers impact into the actual dollars spent to get the stimulus. A bigger multiplier means we get more bang for the buck. My view is that a payroll tax holiday would be great short term stimulus, but there is other programs out there with multipliers greater than 1.
The consensus is that there will be between 9% and 11% unemployment in the next year. Generally, economists say that unemployment can run at 4% to 5%, we can assume 5% for our purposes. Using 5% as the base rate, we are going to have excess unemployment of 4% to 6%.
Using a multiplier of 2x, this means we need stimulus of 8% to 12% of GDP to get back to a growing economy. I am going to err on the slighly high side and use 2.25X as the multiplier, which then translates to 9% to 13% of GDP as stimulus to get back to a growing economy.
With 2007 GDP at $13.9T, we get a suggested stimulus of $1.3 to $1.9T to resume growth in this country. This number is after the multiplier If we use a multiplier of 1.2 as the average multiplier effect (again, this will be addressed in another post), then the amount of money that needs to be spent is:
$1T to $1.6T
Barack Obama is looking at spending up to $1T over the next two years.
When viewed through the lens of this model, we are not doing enough stimulus to get the U.S. economy on track. We need to spend more money to get the economy back on track.