Salient to Investors:

Research by Bradford DeLong at Berkeley and Lawrence Summers shows that with short-term interest rates near zero, the multiplier is at its most powerful, so increased spending could be unusually potent in reviving growth and pay for itself and bring lower deficits in the long run. DeLong said the budget cuts equate to Congress hitting the economy on the head with a brick. Summers denounces the current US obsession with deficit-cutting.

Valerie Ramey at the University of California found that contrary to  DeLong’s and Summers’ assumptions, the US economy is not any more sensitive to government spending during periods of high unemployment and low interest rates.

Martin Eichenbaum at Northwestern University said the danger that the same forces that magnify the strength of stimulus also make austerity particularly harmful. Eichenbaum says the economy is as much as 3 times more sensitive to changes in government spending when central banks are keeping interest rates near zero, so it’s a win-win to fix our infrastructure now.

Studies from Berkeley to Northwestern to the Fed found that in depressed economies, each $1 increase in government spending can generate as much as $2 or $3 in additional economic growth versus little boost in normal times.

Christopher Erceg and Jesper Linde at the Fed found that when a central bank is stuck with interest rates at zero for much beyond two years, increased government spending leads to so much growth that public debt actually falls – there are no costs, only benefits. Erceg and Linde and Michael Woodford at Columbia say for maximum impact, the stimulus must be deployed before the economy improves enough for the Fed to consider raising interest rates.

Peter Orszag says the best path forward is a comprehensive fiscal deal combining upfront stimulus with delayed but credible austerity – two-month budget deals address neither stubbornly high unemployment and a problematic fiscal outlook.

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