Fudging the government spending multiplier

How large is the government spending multiplier? Professor Barro estimate it to be .8 during war times and insignificantly different from zero in peace time. With these estimates one would conclude that the multiplier of 1.5, presently assumed by President Obama's economic team is way out of line and we should not expect substantial benefits from the stimulus package.

A similar point is raised by Professor Fama. He asserts that bailouts and stimulus plans must be financed, and if the financing takes the form of additional government debt, the added debt displaces other uses of the same funds. This being so, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.

Assuming the logic of Professor Fama's analysis is correct, there is nothing in Fama's argument that says that the government multiplier cannot be substantial. Yes it can be small, but it can also be large too. Also note as Professor Krugman has pointed out Professor Fama is interpreting an accounting identity as a behavioral relationship, a common fallacy.

For more see Cochrane and Fama's response to Krugman.