Republicans want to increase the unemployment level

Republicans are calling for spending cuts to be included in any deal to raise the debt-ceiling.

Mark Thoma wonders why Boehner and the Republicans want to increase the unemployment levels in the midst of massive unemployment.

suppose there are $600 billion in cuts over two years. What would be the macroeconomic impact of such a change?

Estimates of the multiplier vary, and the exact magnitude is controversial. Generally, the multiplier is thought to be larger than 1.0 in severe recessions, and much smaller, perhaps even zero, when the economy is near full employment. Assuming a multiplier of 1.0 — a value I think is, if anything, too small given the current state of the economy — a $600 billion reduction in government spending causes a $600 billion reduction in GDP (or about 300 billion per year).

Presently, GDP is just under $14.7 trillion, so a $300 billion change represents a 2% change in GDP. According to Okun’s law, a 2% change in output corresponds to a 1% change in the unemployment rate, so this translates into, approximately, a 1% change in the unemployment rate. The labor force is presently just over 153 million, so a 1% change corresponds to around 1.5 million workers. Thus, employment would fall by 1.5 million workers in each of the two years, for a total decline of 3 million workers.

So, a $600 billion reduction is government spending over two years would raise unemployment by 1% per year, or around 3 million workers in total. We are currently down around 11 million jobs since the start of the recession, and we are not creating jobs at anywhere near the pace that is needed to reach full employment in a reasonable time period (at current rates it would be over 5 years). To stack an additional 3 million lost jobs on top of the large unemployment problem we already have would be a disaster, and I do not expect changes of this magnitude to happen despite talk of “trillions.” Even a much smaller cut, say $100 billion over the next year, would still wipe out 500,00 jobs over that time period — 2 months of job creation at present rates — and set the recovery back considerably.

As noted above, the multiplier is much smaller when the economy is closer to full employment. Thus, when the economy is strong, the output and employment effects of deficit reduction aren’t as severe. We do need to address out long-run deficit problem, and that means, first and foremost, getting the main source of the problem — health care costs — under control. But if we move too soon, if we make big cuts while the economy is still struggling to recover, we will do more harm than good.

The "multiplier" is just a ratio of income over government spending.  Its technically called the "government-purchase multiplier" and it projects how much income rises in response to a $1 increase in government spending. Harvard economist Gregory Mankiw explains in his Macroeconomics textbook why government spending causes an increase to GDP, "high income causes higher consumption.  When an increase in government purchases raises income it also raises consumption, which further raises income, which further raises consumption and so on."

Okun's law is the negative relationship between unemployment and GDP, that a decrease in unemployment of 1 percentage point is associated with additional growth in GDP of approximately 2%.  The reasoning is pretty simple; employed workers help produce good and services and unemployed workers don't so you have more goods and services in an economy with more employed workers, therefore you see a decline in GDP when the number of unemployed goes up.

So the question is if smack dab in the middle of an employment crisis is the right time to push policies that will increase unemployment levels?