A central premise of Keynesian economics is that, during a recession, government spending increases total output through a "multiplier" effect. If the multiplier is 1.0, then every dollar spent by the government on its own consumption -- rather than reducing someone else's consumption or investment by $1 -- adds a dollar to GDP. Money for nothing! Most Keynesians actually claim fiscal multipliers higher than 1.0, meaning that government spending boosts national income by more than the amount of the spending itself. This is what Mises called the Keynesian miracle of turning stones into bread.
Critics such as Robert Barro have argued that US fiscal multipliers, since the 1940s, have been far smaller, perhaps closer to zero (even during World War II, he estimates a multiplier of 0.8). But most economists have conceded the Keynesian point that multipliers are greater than 1.0 during severe economic crises.
A new paper by Price Fishback and Valentina Kachanovska in the prestigious Journal of Economic History provides new evidence on the effect of US federal spending on state-level income and employment during the Great Depression. Fishback (a former student of Robert Higgs) and Kachanovska, estimate state-level multipliers of between 0.4 and 0.96 -- in other words, a dollar of federal spending crowded out from 4 to 60 cents of private investment. They also find that federal spending had no measurable effect on state-level private employment. It's a technical paper, with most of the discussion focusing on the data and econometric techniques, but well worth reading for those interest in business cycles and fiscal policy. As Fishback and Kachanovska conclude: "To the extent that findings for the 1930s are relevant to the modern era, the lack of positive effects of public works and relief spending raise some questions about how successful such expanded spending will be at the state level in the modern era."
