One of the mathematical lodestars of macroeconomics is the “multiplier.” As I have told eager (and not-so-eager) students for many a moon now, the multiplier is a part of Keynesian theory that says, essentially, that $1 in government spending can lead to $3, $4, or even $5 in economic growth (depending upon consumption rates); tax cuts have a similar, though slightly smaller, effect.
Nothing has been more corrosive to the cause of limited government and fiscal sanity than the “multiplier.” It has minimized much of the consequences of deficit spending and debt build-up, while at the same time providing a bias in favor of the larger-government option (spending) over the theoretically smaller-government one (tax cuts).
Several economic schools of thought (the Austrians, monetarists, neo-classicals, and the rational-expectations crew among them) have responded by insisting any multiplication is countered by the loss of investment or consumption due to excess government borrowing (known as the “crowding-out” effect), largely to no avail in the political world.
That may change in the next few years. For the first time that I can remember, economists are beginning to take a long, hard look at the effects of government spending on the economy to calculate (as best as can be done) the multiplier.
The International Monetary Fund came up with . . . 0.7 (John B. Taylor, Wall Street Pit), and the European Central Bank (which looked at the EU) settled on . . . (0.5).
In other words, the effect of government spending in the economy did not multiply; in fact, it didn’t even increase; it eroded.
The importance of this cannot be underestimated. In effect, government spending does not have a greater impact on the economy than letting the consumers and business spend the money on their own (one could even argue a lesser impact). Questions about government spending, how to balance budgets (i.e., cut spending or raise taxes), etc., without the “multiplier” bias, can no longer be answer simply by whatever increases government spending.
In other words, the critics of Keynesianism were right – so much so that “New Keynesianism” now acknowledges the strong possibility of “multipliers” that, being below 1, could actually be called “dividers.” Just at the moment when Barack Obama is trying to build a social democracy, the economic-theory foundations that make it politically possible continue to crumble under his feet.
