Keynesian “multiplier”? Try divider.
By D.J. McGuire | Tuesday, July 20th, 2010 | Policy
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.
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About the author
Former candidate for Board of Supervisors in Spotsylvania, current blogger, economics teacher, and long-rumored windbag. There are two causes closest to the heart: steering the country away from the social democratic nonsense that is sinking Europe, and convincing the rest of the "rightosphere" that the NBA really is a joy to watch.
Comments
6 Responses to "Keynesian “multiplier”? Try divider."
[...] Cross-posted to BD [...]
This issue reflects another instance of conservatives failing to state their case clearly over the past 80 years since the New Deal. It has been well known for years among even many liberal economists that the New Deal spending accomplished very little. Of course they weren’t going to broadcast that fact. But educators have been allowed to spin the New Deal economics for decades as a wonderful example without any pushback until recently. We are going to pay dearly for the increasing economic ignorance of most Americans.
DJ
I disagree with one statement, namely that “Obama is trying to build a social democracy” There is no evidence in his behavior or the leftists supporting him that they want or even admire democracy. Their guiding stars are Venezuela, Cuba and China by their own statements. I know many liberals and most would be quite happy with an authoritarian state. “Good government” socialism probably can only work in a small country with a homogeneous population.
@ D.J.
It’s nice to see a thoughtful blog criticizing Keynesian economic thought.
Unfortunately, as long as various countries and the Federal Reserve are willing to purchase government debt, we’ll be dealing w/ the threat of a social democracy. That’s the unfortunate reality when money is monopolized by federal law through a central bank.
In my opinion, the ultimate solution to effectively reduce the size of government is to eliminate the central bank and allow the market to determine the course of the monetary system.
As long as the government can only directly tax the citizens of the United States and borrow from other nations, the government will be restrained in size. It is the printing press that has given way to the massive government we face today…
Valentinus
conservatives may not have stated their case against Keynesianism clearly, but liberals and libertarians have – it’s just hard to erase fallacy. Bastiat disproved Keynesianism long before Keynes was even born. Check out his work at econlib.org. But compare this to trade. Adam Smith showed that Free Trade is fantastic and should be the policy. 300+ years later? Pelosi is blocking free trade deals and Obama is imposing protectionist tariffs.
It’s really hard to eliminate fallacy when you don’t make much effort at it. Leftists are not going to squeal on themselves so others better do it ASAP. Yes free trade is an issue but the false aura around metastisizing government spending (followed, of course, by shrinking sputtering spending) is the most pernicious problem at the moment. It’s astounding with all the wreckage of 20th (and 21st) century socialist countries that anyone can speak in favor of it without a hundred people telling them otherwise.
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