One of the questions that comes up in every class is: what’s the multiplier? If we increase government spending by a dollar, how much does GDP rise? If I polled my colleagues, I’d get answers ranging from zero (the increase in government spending is offset by a reduction in private spending) to two (each dollar raises GDP by two dollars). My guess is that anything much above one is a stretch, but who knows, the world’s a complicated place.
So what does this have to do with the fiscal cliff, the sharp drop in spending built into current law if Congress fails to enact something else? Someone at lunch today argued (i) the multiplier is zero and (ii) we’ll be in big trouble if Congress doesn’t act.
Your mission: explain why these two statements contradict each other. For extra credit: what multiplier would you need to generate a fall in GDP of one percent if we go over the cliff? And for double secret extra credit: is it ethically ok for Congress to drive us over the cliff so that we’ll be able to find out what the multiplier is?