Thursday, January 7, 2021

The Keynesian Multiplier is the Bigfoot of Economics—Something That Many Assume Exists But Is Rarely, If Ever, Seen

The Keynesian multiplier theory rests on the assumption that a dollar of government deficit spending can produce more than a dollar of total economic output after all secondary effects are taken into account. The multiplier is the Bigfoot of economics—something that many assume exists but is rarely, if ever, seen. The foundation of Keynesian public policy is called aggregate demand, or the total of all spending and investment in the domestic economy, excluding inventories. For example, if a worker is fired, he not only loses his income, but he also then stops spending in ways that cause others to lose income as well. The lost income and lost spending cause a drop in aggregate demand, which can feed on itself, leading more businesses to fire more employees, who then spend less, and so on in a vicious circle. Keynesian theory says that government can step in and spend money that individuals cannot or will not spend, thereby increasing aggregate demand. The government spending can reverse the slide and contribute to renewed economic growth. 

The problem with this theory of government spending to boost aggregate demand is that governments have no money of their own in the first instance. Governments have to print the money, take the money in the form of taxes or borrow the money from their citizens or from abroad. Printing money can cause nominal growth, but it can also cause inflation, so that real growth is unchanged over time. Taxing and borrowing may enable the government to spend more, but it means there is less for the private sector to spend or invest, so it is not clear how aggregate demand increases. This is where the multiplier claims to play a role. The idea of the multiplier is that one dollar of government spending will stimulate more spending by others and result in more than one dollar of increased output, and this is the justification for taking the dollar from the private sector. 

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 184-185.


No comments:

Post a Comment