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Extended Unemployment Benefits: Will the Multiplier Effect Have an Impact?

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Some say yes, some say no. But it seems as if two distinct issues are being conflated by many.

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Now that Congress has extended unemployment benefits through November to millions of jobless Americans, $34 billion will be put into peoples' pockets -- which some believe will have a positive effect on our nascent economic recovery.

Christine Owens, executive director of the National Employment Law Project, said, "People have to spend the money. These are not folks who have other income. So, everything that they get in unemployment benefits, they spend. They're not saving this money, putting it aside for retirement. They are surviving on it."

And economist Ralph Martire, of the bipartisan Center for Tax and Budget Accountability, says that every dollar of unemployment benefits has the impact of $1.74 in the community because people spend the money rather than save it.

"They're desperate," Martire says. "They're letting bills pile up. They've got way too many immediate needs to cover just the cost of living to do anything other than spend that money and spend it immediately."

Martire is absolutely correct. This is indisputable. People in dire economic straits are using every cent that comes in to pay their bills. People do have "way too many immediate needs to cover just the cost of living to do anything other than spend that money and spend it immediately."

However, the Center for American Progress contends that the money put back into the economy from unemployment benefits would "turn around the weak consumer demand that is plaguing the private sector today."

Would it?

Immediate needs such as the ones that Ralph Martire refers to don't generally include iPods (AAPL) or Nike (NKE) basketball shoes. Immediate needs are Con Edison (ED) bills, filling the family car with gasoline at the ExxonMobil (XOM) station to get the kids to and from school, and a shopping cart's worth of food from Safeway (SWY) to feed oneself.

This doesn't tend to foment a turnaround in weak consumer demand, if people have, as Martire posits, "way too many immediate needs to cover just the cost of living to do anything other than spend that money and spend it immediately."

As for the economic multiplier that turns $1 into $1.74, a forthcoming paper from the Cato Institute by Andrew Morris, William T. Bogart, Roger E. Meiners, and Andrew Dorchak, which will be released next year, points out that:

Economic multipliers are familiar in the applied policy literature, having been used to advocate for public subsidies for industries, sports stadiums, and other spending programs. Multipliers are based on the idea that an increase in activity by one firm will lead to an increase in activity by other firms and employees that receive payment from the first. The contractor for a new football stadium buys concrete, the concrete subcontractor buys new tires for its trucks, all the firms' workers go out to dinner, and so forth. There are several standard models of how these interactions promulgate through the economy. A literature review by staff of the International Monetary Fund provides both theoretical and empirical reasons to expect multipliers of various magnitudes. They conclude that multipliers will be larger and positive when increased government spending does not substitute for private spending, when it enhances the productivity of labor and capital, and when government debt is low. If these conditions do not obtain, the multiplier will be smaller and perhaps even negative.

Martire and Owens are correct. People are surviving on unemployment benefits -- not using the money to purchase things they want, but rather, things they need.

Let's not conflate an emergency source of funds to be spent on necessities by those in financial distress with a true increase in consumer demand.

Extending unemployment benefits may solve a specific short-term problem, but it won't solve the one that will restart a stalled economy.
No positions in stocks mentioned.
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