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Macro Thought Experiment II

Here’s another macro thought experiment.

A government economist notices that 25% of the job losses in the economy are from the construction sector. To help speed the recovery in the job market and reduce unemployment:

1. the government decides to build 1,000,000 government houses and sell them cheaply to qualified (low-income buyers)

2. the government decides to build 1,000,000 government houses and then tear them down.

3.  the government decides to pay the out of work construction workers their previous salaries for the next two years.

A variation would be to take any of these scenarios and continue them every year, indefinitely. Call these 1i, 2i, 3i.

BTW, here is employment in the construction sector as defined by the BLS:

So you can see that from the mid-1990s through 2006, employment in the construction sector rose well above trend.

Any of the three scenarios would “solve” this problem and get employment back to something close to its previous high level. It might end up taking an expansion of new houses of a larger level–say 2,000,000 houses per year.

What would the effects of these scenarios be?

In scenario 1, there would be crowding out of private home building activity. The expansion of government houses would bid up the prices of home building materials. The competition in the real estate market would hurt private sales. Only the former effect would exist in the second scenario. Neither effect would exist in the third scenario.

Would any of the three help the economy outside of the people who get the money–builders and workers in the first two scenarios–workers in the third one? Would it matter how the increased government expenditures were financed?

In a Keynesian world, all three help the overall economy through an increase in aggregate demand and the multiplier.

In the real world, scenario 3 is better than either of the first two. The first two scenarios use up real resources (that are typically not underemployed–lumber, etc and steer them to the less productive use than what they would otherwise go to.) But as I have written before, I don’t understand how even scenario 3 would help an employer feel more confident about the future and eager to respond to demand increases by expanding output and hiring.

Ironically, in the real world, animal spirits make Keynes’s world less plausible.