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Who Knew the Economy Was So Dependent on Unemployment?


Two days ago, the Washington Times ran this story about how failing to extend unemployment benefits would hurt the economy:

Unemployment benefits help drive the economy because the jobless tend to spend every dollar they get, pumping cash into businesses. A cutoff of aid for millions of people jobless for more than six months could squeeze a fragile economy, analysts say.

While I can understand the argument that extending unemployment benefits would help those dependent on them avoid hardship, I don’t understand the claim that unemployment benefits are stimulative. As always, arguments like this one rest on the theory that government spending is stimulative and has a spending multiplier bigger than 1:

The Congressional Budget Office says every $1 spent on unemployment benefits generates up to $1.90 in economic growth. The program is the most effective government policy for generating growth among 11 options the CBO has analyzed. Mark Zandi, chief economist at Moody’s Analytics, puts the bang-for-a-buck figure at $1.61, and a recent Labor Department study estimates it at $2.

The CBO says it, but that doesn’t make it true. In the last two years, many economists have pushed back on the idea that multipliers like Zandi’s and the CBO’s are accurate. That’s because their models are based on the built-in assumption that government spending does create growth, whether this is correct or not. Many academic research projects have settled on estimates of the multiplier much lower than the ones used by Zandi and the CBO. Other scholars have shown that, in spite of Zandi’s original predictions of the economic impact of the stimulus, the result was quite different. My colleague Matt Mitchell properly says:

We can quibble about which estimate is right but it seems that many proponents of stimulus are over-confident in their assessment that fiscal stimulus works. Given the ambiguities in both the theoretical and empirical research, I’d say a little humility is in order.   

The claim that unemployment benefits have a real stimulative effect rests on the assumption that low-income earners have a strong propensity to consume their income rather than save it. But, as Mitchell writes:

In my mind, this makes theoretical sense. The problem is: it doesn’t seem to be true. And President Bush’s Stimulus I provides the evidence. Economists Claudia Sahm, Matthew Shapiro and Joel Slemrod studied the way people spent the stimulus checks that were sent out in the first half 2008. Using data from the Reuters/University of Michigan Survey of Consumers, they found that spending patterns were “strongly at odds with the conventional wisdom.” It turns out that the poor were actually less likely to spend their 2008 stimulus checks than the wealthy. What’s more, analysis of the 2001 stimulus found much the same thing.

He also notes that even if “poor” and “unemployed” are not necessarily the same, academic research at Northeastern University has shown that the correlation is extremely strong. 

Finally, it is important to keep in mind that while we wish to help people in need, unemployment benefits may not be the best way to do it. That’s because there are unintended consequences to subsidizing unemployment. For instance,  numerous studies, including some by Larry Summers, have found that increasing the length of duration of potential unemployment benefits increases the average length of unemployment.

Thanks to Jim Musser for sending me the Times article.