Stimulus package's multiplier effect depends on credit availability

Posted Jul 23rd 2009 4:20PM by Joseph Lazzaro
Filed under: Forecasts, Financial Crisis

The U.S.'s $787 billion stimulus package has come under criticism for being too small, too elongated, and too ineffective, and all are at least partially valid points.

A better program would have pushed much more money out in the first three months - say as much as $500 billion - to create the largest possible impact on U.S. GDP.

Economists call this the 'bigger bang for the buck' theory: a one shot, $500 billion stimulus jolt moves the GDP needle more than a $200 billion / $200 billion / $100 billion disbursement, all other factors being equal.

Credit markets: circulation system of commerce

Still, critics of 'Stim 1' should not forget one fact (among others): working against the stimulus has been the financial crisis. How so? Because credit availability can increase/decrease a stimulus package's multiplier effect. Here's why:

A state or jurisdiction may get $20 million to help build a new, larger mass transit center in a city, but if the city can't float bonds to borrow the additional $80 million needed for the project, the stimulus money could lay fallow, or be used for other projects that don't require bond funds. Net impact: some jobs created in a $20 million expenditure, but most likely fewer jobs than a $100 million project.

The above underscores the need for policy makers to work to normalize credit markets as soon as possible. Without loans, Stim 1 won't stimulate or generate as nearly as much commerce as it would under typical market conditions.

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