Keynesian multiplier effect?

Discussion in 'Economy' started by Norman, Feb 22, 2011.

  1. Norman
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    Norman Gold Member

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    Hello,

    I am just reading about this keynesian multiplier effect in an econ book, and TBH it seems like complete BS. Let's not focus on how stupid it sounds that by forcing you to spend and buy crap an economy is going to get better, but on the "fundamentals" of the theory. And I am sorry if I don't understand this argument (so please someone fix this up if I am wrong).

    1) Anyway my problem with the multiplier effect is that the money has to be first taxed from people before it can be spent. And after it's spent you start counting how many times it "ripples". But money by default circulates, so it would have circulated/multiplied regardless of government taxing and spending it. Why is the "average" multiplier not taken out of the after public spending multiplier?

    2) It states that the money and thus GDP multiplies always only on spent money. But WTF, invested money does circulate too...

    To see failure in this, what could be one place you invest into... how about govt bonds! So if invested money doesn't multiply that is actually a logical paradox. In order to create the multiplier you have to invest to government, but at the same time cannot invest?

    3) Of course if you increase demand, prices have to raise, and those price rises will affect the producers too, so why would they produce any more? Sure short term the prices may lag, but this kind of thing will also create all kinds of distortions without doubt. Not to take into account the uselessly spent money and resources.


    So in short, to my eyes this theory seems totally bankrupt, especially the 2) Paradox seems inevitable. Or does the theory consider savings as something you put into sock?

    Anyway maybe I am totally wrong, let's discuss about the keynesian multiplier (BTW I am not sure if it originated from keynes).
     
    Last edited: Feb 22, 2011
  2. 8537
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    8537 Senior Member

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    Money invested in productive capacity (As opposed to money "invested" in a transfer of savings) = spent money. It increases GDP and has its own multiplier.

    The basic idea is far older than Keynes and comes from a simple interpretation of the equation of exchange. Keynes re-interpreted it to some degree, adding effects for government spending etc...
     
    Last edited: Feb 22, 2011
  3. Oddball
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    Oddball BANNED Supporting Member

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    All you need to understand is that Keynes basically used elaborate charts, graphs and incomprehensible formulas to try and prove that there really is free lunch.
     
  4. boedicca
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    boedicca Uppity Water Nymph Supporting Member

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    Funny that you mention Free Lunches - I was just about to look for the following piece regarding the Keynesian Multiplier.

    In wartimes, it has been, at best, .8. Without a war it is virtually zero.

    Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called "multiplier" effect of government spending on economic output is greater than one -- Team Obama is reportedly using a number around 1.5.

    To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy's total output expands by enough to create the airplane or bridge without requiring a cut in anyone's consumption or investment.

    The explanation for this magic is that idle resources -- unemployed labor and capital -- are put to work to produce the added goods and services.

    (snip)

    We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War -- although the magnitudes of the added defense expenditures were much smaller in comparison to GDP. Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before. (These estimates were published last year in my book, "Macroeconomics, a Modern Approach.")

    There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero....


    Robert J. Barro: Government Spending Is No Free Lunch - WSJ.com


    Obamanomics has way overstated the impact of government spending upon positive economic growth. This is why the Stimulus failed to reduce unemployment to 8% and why, only a few months later, the deficit is far greater then they forecasted for this year.
     
  5. william the wie
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    william the wie Gold Member

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    It was Hicks and Hanson that came up with the graphs used in the Keynesian model. The whole idea of economic modeling has a number of flaws:

    It cannot address black and gray markets.

    It omits demography.

    It assumes that normal curves and algebraic functions are all that are needed to describe the economy. This is false.

    The question is is there any model simple enough to use that is worth using? My answer is no.
     
  6. 8537
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    8537 Senior Member

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    if you read the General Theory, you'll find no formula's longer than three or four variables and very few charts - none of any great complexity. Keynes didn't even invent the cross-diagram that bears his name.

    You're mistaking him for the monetarists that followed.
     
    Last edited: Feb 22, 2011

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