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Research desk: Will defense cuts harm the economy?

at 02:06 PM ET, 10/26/2011


(Donna McWilliam/Associated Press)
PJA2 asks:

If the Supercommittee doesn’t reach an agreement, there will be large defense cuts. Although it might not be the most productive use of the money, most of it must end up back in the economy somehow. Are there any estimates of what the effect on the economy will be if the defense cuts happen?

Robert Barro and Charles Redlick released a paper in 2009 calculating the “economic multiplier”— that is, the GDP bang per spending buck — of defense spending, using data from 1914 to 2006. They found that during normal economic times, the multiplier is about 0.67, and is higher when the economy’s weak, rising by 0.05 for every percentage point by which unemployment exceeds 5.6 percent. Given last month’s unemployment rate of 9.1 percent, the multiplier would be about 0.845. That is, each dollar of defense spending currently grows the economy by about 85 cents.

If the supercommittee’s trigger goes off, about $500 billion will be cut from defense programs, starting in 2013. Thus, assuming that $50 billion is cut in 2013 specifically, and unemployment is still where it is today, the cuts will reduce GDP by about $42.25 billion - or 0.2 percent of our current $15 trillion GDP. If unemployment falls, the multiplier will shrink and so the hit to GDP will be lower, and if the economy grows, then the hit as a percent of GDP will be lower as well.

It’s worth noting, though, that while certainly stimulative, military spending isn’t the most stimulative thing the government spends money on. Mark Zandi of Moody’s estimates that the multiplier is 1.74 for food stamps, 1.61 for unemployment benefits, and 1.57 for infrastructure spending. The trigger’s cuts to those sorts of programs, thus, would cause much more economic damage relative to the size of the cuts than the defense cuts would.

 
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