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The Keynesian Multiplier – Does it Exist?

Economics / Economic Theory Feb 03, 2014 - 04:27 PM GMT

By: Submissions

Economics Dan Lieberman writes: Can someone clarify a significant economic and well accepted proposition that bothers me?

The notion that the Keynesian multiplier means that “an exogenous increase in spending, such as an increase in government outlays, increases total spending by a multiple of that increase,” is troublesome. Is it possible to add one dollar to the money supply and magically turn it into more dollars? I don’t think this is possible. I believe economists have misinterpreted the multiplier. To me, it is not a multiplier. It is a divider.

The concept actually states that if the total investment is not consumed then not all of the investment is available for reproduction, and with time the value of this investment to the economy will fade to nothing.

Let me explain.

First, the proper parameters must be set.

(1)   Velocity of money and time are not factors in the concept;

(2)   Added borrowing, such as fractional banking, is not factors in the concept.

(3)   Spending is only for produced goods and not for any services. (In the service economy the added GDP can be multiplied.  A buys a service from B who buys a service from C and so on...)

(4)   The government spending is deficit spending, supported by borrowing and not by taxes.

The aspects of the Keynes's model, which support the multiplier, present these arguments:

1.     The people who receive this money then spend most on consumption goods and save the rest.

2.     This extra spending allows businesses to hire more people and pay them, which in turn allows a further increase in consumer spending.

Missing from this argument is that the original production, stimulated by the investment, is only repeated by money already available in the economy. A simple example shows this phenomenon.

Let us have four production units – A, B, C and D. Government deficit spending (investment)  of one million dollars purchases trucks and so a trucking company adds another production line called E.

The company hires workers, makes no profit and pays them the one million dollars. The government has the trucks and there is an additional one million dollars in the economy. The company has no added assets to its books and cannot repeat the production unless someone else invests.

The new workers from E purchase the product from D; the workers from D then purchase the product from C; the workers from C purchase the product from B and the workers from B purchase the product from A. Spending matches production, demand matches supply, but wait the workers from A still have to spend their income. Well, they can finance another round of production from E and if this happens, the production cycle starts all over again. Essentially the previous government investment, which is no longer available, is replaced by investment from the workers of A. Nothing more has been added to the economy than the original government investment. The total demand and supply have increased by only the government investment and not more. Production cannot be more than A+B+C+D+E. There is no multiplier.

If the workers in each company do not purchase full production, but purchase imports, save, or let the wages circulate in monetary speculation, then not all of the government investment is available for reinvestment and the succeeding production cycle will be less than A+B+C+D+E. If this manner of spending continues, then, in the limit, the production will retreat to A+B+C+D, the value before government intervention.

It is also obvious that if government spending had a multiplier factor then the best system would be one of severe government deficit spending. Deficit spending has only replaced the lack of private borrowing and historical statistics of GDP and money supply demonstrate that their growths have always been less than the spending – so where is the multiplier?  

Appreciate a reply so I can sleep tonight.

Thanks for your interest.

Dan Lieberman


© 2014 Copyright Dan Lieberman - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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