Robert J. Barro, Harvard economics professor, is joining other economists crying out against the massively aimless spending in the $820 billion “stimulus” bill before Congress.
He says the multiplier effect on the economy of such peacetime government spending will be “insignificantly different from zero.”
Specifically, he writes:
“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.”
Tax cuts. Barro says a real stimulus bill would be focused on cutting taxes wherever the tax cuts would encourage more investment, production and work. Where there is more spending, he says, make sure it’s on projects calculated objectively to be as likely to boost the economy as tax cuts. He says:
“On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.”
High stakes. I hope President Obama is studying the facts that reasonable economists have been giving him over the last 10 days. You can’t borrow and bet $820,000,000,000 without some expert assurance the bet will pay off.
For decades, we may have no more chances to borrow that much money in an emergency. So please, get this right.
Frank Warner
* * *
Welcome Ohio High Forum!
See also: Germans know that debt can kill an economy.
See also: Economist Martin Feldstein: Wait a month or two to avoid ‘stimulus’ mistake.
See also: ‘Stimulus’ bill: Some economists ignore all data.
See also: The ‘stimulus’ bill looks like a bad last bet.
See also: Larry Summers rules: Stimulus must be ‘timely, targeted, temporary.’
See also: Harvard’s Lucian Bebchuk: Competing ‘bad banks’ could hold down the cost of financial recovery.
* * *
What is the “multiplier effect” in economics? It is the ripple effect of spending or investing a dollar, as expressed in the number of times that dollar will circulate through the economy, producing additional national income. It also is the ripple effect of the government reducing someone’s tax burden by a dollar, or of a bank reducing an interest rate enough to free up a dollar. That multiplier would be expressed in the number of times each of those freed-up dollars will circulate through the economy, producing additional wealth.
John Maynard Keynes theorized that additional government spending, or tax cuts or interest rate reductions would help a nation out of a recession by flooding the economy with new dollars that would circulate from consumers to retailers to distributors to manufacturers to workers, and back to consumers and so on. Other economists disputed Keynes’ theories, noting that the initial spending, tax cuts or interest rate reductions take money out of the economy, and that lost wealth creates its own economic drag.
Some economists argue that cutting tax rates on specific economic activities is more likely to boost the multiplier effect because wisely targeted tax cuts also are an incentive to work, invest and produce more. Other economists calculate that the economy can see a good multiplier effect from government spending on big construction projects, such as highways, bridges and other needed community facilities (infrastructure). Big construction projects are considered good multipliers because each general contractor hires subcontractors, and all of the companies involved tend to hire large numbers of workers and purchase large amounts of materials, pumping up economic activity.
Banking multiplier effect. In banking, the “multiplier effect” is different. It refers to how much money the banking system creates based on its required minimum reserves. For example, a bank could be required to keep in reserve $20 of every $100 its customers have deposited. That makes 80 percent of the bank's deposits available for lending. In this example, as the cash runs from one bank to another in the form of loans, eventually the $100 becomes $500.
* * *
See also: Barro speaks.
See also: March 4, 2009: Professor Barro: 20% odds of a depression.
See also: Oct. 19,2009: The Myth of the Multiplier:
Robert Barro’s work and research by Valerie Ramey, an economist at the University of California–San Diego, on how military spending influences GDP. Both studies found that government spending crowds out the private sector, at least a little. And both found multipliers close to one: Barro’s estimate is 0.8, while Ramey’s estimate is 1.2. This means that every dollar of government spending produces either less than a dollar of economic growth or just a little over a dollar. That’s quite different from the administration’s favored multiplier of four. What’s more, Ramey also found evidence that consumer and business spending actually decline after an increase in government purchases.
Just to point out that there are actually economists who support the plan, here's Paul Krugman in the NYT.
That’s why we’re talking about large-scale fiscal stimulus: it’s what’s left in the policy arsenal now that the Fed has shot its bolt. ...
[W]hen it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved. ...
Posted by: jj mollo | February 01, 2009 at 06:01 PM
Can we find someone other Krugman? As I recall, he had us in recession all eight years of the Bush administration.
A targeted tax credit, giving a break to those who actually spend, cannot be saved. So the argument about saving tax cuts doesn't work.
Keep in mind, both Hoover and Roosevelt spent big, with almost no effect except to produce the longest recession-depression in U.S. history.
Some spending probably would help, particularly on big highway projects. But that's what? 2 or 3 percent of the total "stimulus" bill?
I expected maybe 10 percent of the bill would be pork. But about $500 billion is pork, more than half. That's about the cost of the entire Iraq war, and we'll have almost nothing to show for it, except an amazingly huge debt and no one left to lend us another penny.
But I'm open to a good argument that continued wild borrowing and spending will save the economy. Don't ask Alice Rivlin to make it.
Posted by: Frank Warner | February 01, 2009 at 06:14 PM
Frank Warner estimates that $500 billion of the stimulus bill is "pork", meaning that it doesn't consist of tax cuts. This is a redefinition of the term in order to serve the current right wing agenda.
Until now both Republicans and DEmocrats have agreed that "pork" refers to expenditures that are specifically directed to the district(s) of the Congressional representative(s) responsible for the bill. By that (proper) definition, there is virtually no pork in the stimulous package.
Krugman's not the only one who disputes the Republican mantra that only tax cuts stimulate the economy or creat jobs. Both the General Accounting Office and the Congressional Budget Office have examined the effects of tax cuts on the economy; and both report that these do not reliably increase government revenues, the nation's GDP, or employment, when compared to appropriately targeted government spending programs.
I realize that the New Deal remains a perpetual embarrassment to libertarian dogma; but merely repeating the same inaccurate historical revision - that the New Deal was a failure - doesn't change the facts.
Posted by: AJ Hill | February 13, 2009 at 03:41 PM
AJ, you sound like a Democratic Party robot.
Talk about mantras. Geez, at least argue the facts.
Pork generally refers to wasteful fat in legislation. Fortunately or unfortunately, there is plenty of disagreement over what is pork and what isn't.
When $500 billion in spending is poorly thought-out, when it can burden generations with debt for benefits promised but unproven, it's pork.
As an open-eyed liberal, I wanted a stimulus bill based on solid economic history. Most of the spending in the bill now being passed has little stimulative effect, and by taking $500 billion out of the economy for this conglomeration of a bill, it may well make the economy worse.
Of course, as a faith-based Democrat, AJ, you can't be skeptical for one second. You close your eyes and make wishes. That's not liberalism.
Posted by: Frank Warner | February 13, 2009 at 03:59 PM
Regarding the definition of "pork-barrel spending" you are simply wrong!
I challenge you to find any reliable discussion of the phrase that doesn't refer to the self-serving nature of the appropriation process by the legislators involved. Senator Robert Byrd was for a long time the poster child for pork-barrel spending.
I quote from the first four entries in a Google search for "pork-barrel spending."
(1) Wikipedia: "The term pork barrel politics usually refers to spending that is intended to benefit constituents of a politician in return for their political support, either in the form of campaign contributions or votes."
(2)Citizens Against Government Waste: "pork-barreling is the appropriation of money in circumvention of established budgetary procedures" by politicians "inserting personal projects into appropriations and authorization bills to try to win favor back home."
(3) America.gov: " 'pork barrel spending' [is] a term that traces its origins back to the era of slavery before the U.S. Civil War, when slave owners occasionally would present a barrel of salt pork as a gift to their slaves. In the modern usage, the term refers to congressmen scrambling to set aside money for pet projects in their districts."
(4) PorkBarrelSpending.com: "In modern times pork barrel spending, pork barrel projects, pork barrel bills, pork barrel politics, and earmarks, all pretty much mean the same thing - wasteful spending by congress. Its the practice of getting legislation passed that funds pet projects in a politicians home state or district."
Then there's a report on the ABC News website by John Cochran which says this: "Tax money spent on small projects that only benefit one congressional district or region are often slipped into legislation at the 11th hour -- a time-worn and much criticized part of Congress known as pork-barrel spending."
You will note that only one of the five refers to waste. The central point in each, however, is the nature of the appropriation process. Republicans have chosen to redefine the term "pork" in the debate over the stimulus bill, because they think it's a more effective perjorative in their preferred form of communication, the sound bite.
Moving on to another of your contentions, you claim that "most of the spending in the bill now being passed has little stimulative effect." Bearing in mind the crucial adjective "most" I challenge you to back up this statement. I don't mean by nit-picking a couple billion here and a couple billion there. You should be able to identify the major portions of the $500 billion appropriation and present defensible reasons to conclude that they won't stimulate the economy.
Posted by: AJ Hill | February 13, 2009 at 07:38 PM
AJ, You're right that Frank should be able to support his contention that the the bill doesn't have a stimulus effect. However, after giving him a hard time over a shade of meaning in the word "pork", I don't think you have the standing to accuse him of nitpicking.
Posted by: jj mollo | February 15, 2009 at 02:34 AM
jj - Objecting to the mischaracterization of hundreds of billions of dollars in the stimulus bill as "pork" is not what I would call nit-picking. The assumption implicit in the designation "pork-barrel" is that an appropriation is self-serving, underhanded, and presumably unnecessary. This is not a "shade of meaning"! Whatever the virtues or defects of the stimulus bill, none of it (I repeat: none of it!) satisfies the traditional definition of "pork". In other words, the Republicans are lying and they are doing it in the usual lockstep manner that typifies their most disingenuous behavior. For Frank to endorse their lie - especially when he's wrong - is reprehensible.
Posted by: AJ Hill | February 15, 2009 at 10:30 AM
Most of the whole damn bill, that not one of them read before voting on it, is a gigantic earmark for the Dems. They are repeating the failed economic policies of the Great Depression that actually lengthened the Great Depression.
But let's not worry about history. This is The One in charge now. His vast executive experience and his vast experience in economic matters will take this country out of the abyss and right up to the summit. tic
Posted by: CJW | February 15, 2009 at 12:23 PM
The question is rightfully to what extent the stimulus package represents pork, not the meaning of the word. We all have a good idea what Frank means by the word. You pretend now that you were focused on the substance of the question rather than taking offense at a pejorative description.
Personally, I don't think it matters. Right now, and only while the economy is down, spending is a good thing, and I mean spending of any kind. The best kind of spending in our current situation is money distributed on a retail basis. Get it out to poor people. Get it out to medical institutions, colleges, cities, states. Give food stamps to drug addicts for all I care, as long as we give it to someone who will inject it into the national economy. Pork, pork, pork! Glorious pork!
The only thing that surprises me is that the GOP won't get with the program. The Dems would be overjoyed to add defense spending to the whole shebang. Just give us a few votes in the Senate. Make it look like you care. It seems a very strange time for the GOP to get religion all of a sudden. They've been spending like trophy wives since Reagan got elected and they have the nerve to call Democrats financially reckless.
Posted by: jj mollo | February 15, 2009 at 07:29 PM
Are all of you serious? What is pork? Looking up definitions? Seriously? Call it whatever you want and spend it however you choose, it is physically impossible for a bankrupt government who can only obtain revenue via taxation or borrowing to 'spend' on a stimulus bill and create anything. At best, any job made (not created) will simply be the result of a lost job elsewhere as resources are simply reallocated. The only way out of this or any economic downturn is to create wealth. This stimulus package cannot, by definition, succeed. Forget your party affiliation or your recent presidential vote...our democracy cannot survive if Americans are more worried about defending their team instead of the integrity of the game.
Posted by: Efrapp | February 17, 2009 at 12:11 AM
Creating jobs is not a zero-sum process. An economy could theoretically keep creating jobs until everyone was working. The problem in this economy is that nobody is buying. We are capable of producing much more. And we are capable of producing stuff that people would buy if they had the money. The equipment is there, the people have the skills. The "wealth" is there in terms of hardware. We just don't have the money in circulation.
Bankruptcy for a government lies on a continuum. If anyone accepts my currency, I am not bankrupt. Inflation is the measure of that condition. As long as I can produce something that other people want to buy, I am not bankrupt.
Money can be artificially injected into the economy without borrowing from current uses or increasing taxes. For one thing, we can just print it. We could stop prosecuting counterfeiters. The government could issue credit cards. We can reduce withholding rates. Money is a mechanism for managing the exchange of goods and services. It doesn't always work as it should, and when it misfires, people get confused. They stop consuming and stop working.
This "wealth" that you claim must be created is actually already there, but it's sitting idle because of technical disruptions in the markets.
Posted by: jj mollo | February 17, 2009 at 12:40 AM
Well, I do appreciate your mature response to my post and hope we can continue engaging while avoiding the pitfalls some of the previous posters fell victim to.
Your post however seems more theoretical than realistic. Your points seem one dimensional per economic theory/law/history. You state that "As long as I can produce something that other people want to buy, I am not bankrupt." which is beautiful theory. BUT, if upon producing your desired good or service, you owe more than you earn and/or if upon producing the desired service or good, you do so at a loss, bankruptcy is attainable even as your good/service is flying off the shelves.
From there your arguments lose all sensibility...Printing money would inject money into the economy while simultaneously making that money worthless (which shockingly is what they are doing!!!). Inflation is not theoretical.
Government issued credit cards? How exactly would that work? In a creditor/creditee situation, someone has to provide the upfront value. I buy a DVD player on a Visa card, the merchant gets their 100% and I pay back Visa in installments. The government would pay the retailer and I would repay the government? Can't work by definition. First off, the government doesn't have the money to pay upfront so they'd have to get it from...ME (and you).
I think the 'wealth' you refer to as already existing might better be defined as value.
For the record, I would fix the current problems by eliminating the cap gains tax, corporate tax, estate tax, make Bush tax cuts permanent and other targeted tax cuts. The housing issue is admittedly more complex but in the end, we have to let it fix itself.
Posted by: Efrapp | February 17, 2009 at 10:51 PM
I hope my ideas didn't lose all sensibility. I hope I was at least nibbling around the toes of the truth.
I believe the program of tax cuts that you espouse is generally appropriate for the current situation as a temporary measure. The current stimulus package, which the GOP has been fighting so hard to defeat, does contain a lot of tax relief money. When the economy is doing better, however, I think it is more important to run a surplus, which means that taxes must exceed expenditures. Since 1980, there has been an effort to do so only under the Clinton Administration.
Printing money, by the way, does not cause the value of a currency to collapse. It causes the value of the currency to be diluted. Printing too much money might cause a collapse, but it would be hard for the US to create money fast enough to bring that situation about. Right now, there is some fear that the opposite problem, deflation, might take control. This means that your money would be worth more, if you have any, but, unfortunately, your debts would expand correspondingly.
You obviously feel strongly about your ideas, which seem to me to be somewhat mercantilist. I think you would enjoy some broader reading in economics. Since you seem to be leaning Republican you might consider reading some more libertarian thinkers like the Chicago School. I really enjoyed reading Milton Friedman when I was younger. Today, however, Keynesian thinking, which is more associated with Democrats, seems to be making a comeback.
Posted by: jj mollo | February 18, 2009 at 06:23 PM
Well, I will say, I tend to be a black and white sort of person. While I recognize the gray issues, economics to me is far more math/science than theory. Not that I don't recognize the theoretical aspect of economics but I always bring it back to what seems to me to be common sense. My matter of fact style often derives from the common sense resolution that always seems so obvious but, I admit, it is relative.
Having said that, I would challenge your assertion that the Clinton years were the only time there has been an effort to have revenue (via taxation) exceed expenditures. It does seem the federal expenditure issue has magically circumvented party affiliation/loyalty and struck both Dems and the GOP. But, stats show that following tax cuts, while there may have been a 12-18 month lag for obvious reasons, revenue then skyrocketed. The short answer is that asking 100 people to pay $10 is not as good as asking 500 people to pay $3.
The tax 'cuts' in the current stimulus package are more geared towards temporary tax credits which in many cases are for those who never paid any income taxes in the first place. One could argue that regardless of who is receiving the funds, as long as they spend it, it will help. I would revert to my original argument that the money is just being moved from one resource to another and will not help anyone in the intermediate or long term. It will actually hurt the most vulnerable the hardest.
You are absolutely right that deflation is a current concern. Additionally, I do intend to expand my economic reading as I recently focused on several Thomas Sowell books. Although, on the issue of government spending to stimulate a stagnant or recessionary economy, Keynes will need to be extraordinarily persuasive as I seem inherently disposed against it.
Posted by: Efrapp | February 19, 2009 at 12:48 AM
Many of the sciences have essential tenets that are counter-intuitive. Economics, in something pertinent to our present situation, talks about a paradox of saving. Individuals wisely choose to save money when they expect hard times, but due to the aggregate effect of that choice, they end up having less expressly because of their attempts to save.
I hadn't heard of Sowell. Sounds interesting. I'm particularly taken by his classification of people according to the "vision of the anointed" vs. "vision of the constrained realist". Some of us are optimists about the nature of people and distrustful of institutions. Others (the tragic vision) believe that humans are flawed, and only the social institutions, such as rule of law and constitutionalism, protect us from human failings. I suspect he's mapping his idea of liberalism vs. his idea of conservatism.
I guess I can see both points of view and I don't think I accept his idea of liberalism.
Posted by: jj mollo | February 19, 2009 at 11:33 PM
Well, I think we are getting close to our core differences. I've read a little about Keynes in the last few days (via Krugman which I have found exceptionally difficult to stomach)and simply do not fully embrace the entire savings paradox.
I think people "hoarding" cash is a RESULT of a contracting economy, not a cause. I do believe in the natural ebb and flow of economic cycles and any growing economy will eventually have excess. History seems to show that a free (not laissez faire) market corrects these problems faster than any gov't policy.
Keynes, in the admittedly very little I've read, seemed to think he could adjust for this. My biggest problem (here comes my black and white mentality again)is that the idea of government "stimulating" the economy is that their only resources come from someone else. It is still, to me, a shell game.
This current problem seems more and more to be rooted in the Greenspan monetary policy model. Interest rates were kept too low for too long and skewed the free market. Too many people were 'able' to get mortgages that, had interest rates moved naturally, would have been priced out properly. Obviously that is one dimension of a very multi-faceted problem but I think it plays a substantial role.
Posted by: Efrapp | February 20, 2009 at 10:31 PM
All government resources ultimately come from someone else, that is, someone other than the government itself. Of course, the same applies to every person as well, except for the actual labor that we put into products and services that we ourselves consume. (My family has a vegetable garden where the seeds come from last year's crop. Of course, we didn't create the land.)
Please note that the benefits produced by government services are frequently of available to all. While there is considerable argument about the allocation of government investments, the benefits generally far outweigh the cost of providing them. That's one reason why economies expand. Projects, public or private, often pay back more than they cost. Even earmarks can sometimes represent a net-positive use of funds. Political arguments generally hinge on the relative distribution of benefits and the relative distribution of the tax burden.
I agree about the problem with Greenspan's policy, but he was restricting himself to a monetary viewpoint. The core of the problem was a misallocation of investment into real estate, as you suggest, but also the deliberate mislabeling and mispricing of the investment by investment banks. Lack of monitoring by the government, by the SEC, the banks and Moody's were all to blame there.
IMO, the crux of the problem was the artificially low price of gas, which kept exurban development financially feasible in high-growth states. The sacred tax deduction on mortgages, and other inducements, also kept people investing beyond their means. Real estate values rose without limit and people responded with irrational exuberance. When oil prices eventually rose in response to excessive development-fueled demand, then people couldn't keep up and the bubble burst.
Posted by: jj mollo | February 21, 2009 at 11:28 PM
One could argue the crux of the problem was the artificially high price of gasoline in 2006, 2007 and, until October, 2008.
Whichever energy sources we depend on, the price always will go up and down. But you can be sure of one thing: If we don't try to expand economical energy supplies, we won't expand them, and the energy shocks will return more frequently.
What's missing from all the huge "economic stimulus" programs right now? Any serious project to expand our oil, gas and nuclear energy supplies. A bad mistake.
Posted by: Frank Warner | February 22, 2009 at 05:20 AM
At last, we've really gotten to where you and I go in completely opposite directions. I would argue vehemently (albeit politely and respectfully) against two of your assertions.
1st, your point that, like government, all resources come from somebody else is a major fallacy some prescribe to. In the private sector, we do not function in a zero sum game. Wealth is created. An employer, employee and consumer can all benefit in a free market. Nobody loses if they are making their own decisions and bearing any associated risks with the transaction. That is the key difference between gov't and the private sector. And the key reason I have so little..actually no...confidence in the stimulus package and mortgage bailout.
Secondly, your assertion that the benefits provided by government services generally far outweigh the costs of providing them is simply unsupportable. I understand the benefit aspect but, when cost enters into the equation, that benefit often, very often, is diluted beyond any defensible point.
I am sure both of us lack the time and I know I lack the inclination to start number crunching but I would feel confident and willing to accept the requisite risk in guessing/assuming that if someone were to do a cost/benefit analysis of gov't spending they would find a very poor ratio. It's simply the nature of the beast. Gov't lacks every organic element a private sector employs that makes it such an efficient system. Profit incentive, price based, market based economies contain an efficiency no gov't can ever attain.
There have been several excellent (although I'm guessing that is a relative judgment based on one's viewpoint) op-eds in the Wall Street Journal in relation to the current crises. Fannie and Freddie were forced by congress (and the threat of lawsuits and aggressive regulatory assertion) to expand into what we now consider to be bad loans. These demands certainly didn't put banks in the best place to weather a real estate market downturn.
You're absolutely correct re: the SEC and other regulatory agencies as well as the credit agencies. The SEC doesn't surprise me (per my above total lack of gov't to do much right) but to see Moody's and other ratings agencies miss the boat tells us that they either were dealing with very convoluted products OR were too cozy with those they were supposed to be analyzing.
Posted by: Efrapp | February 23, 2009 at 05:30 PM
Efrapp, Fannie and Freddie were not forced by Congress to expand into "what we now consider to be bad loans." They were forced by Congress to back and buy what they then knew to be bad loans.
Posted by: Frank Warner | June 22, 2010 at 04:10 AM
Why Economic Stimulus Can’t Work
Stephen C. Apolito, CPA
President Obama recently returned from the G20 Summit held in Toronto having failed to convince world leaders that more “economic stimulus” was needed to cure what ails the world’s economies. Walking a seeming tightrope between too much spending and spiraling deficits on the one hand, and too little spending and economic recession on the other, world leaders reluctantly agreed to err on the side of fiscal and monetary caution, and to halve deficits in three years.
Economist Paul Krugman in response to this decision cautioned that this policy of deficit reduction is a mistake. In his opinion the world suffers from “inadequate spending” not too much spending.
Is this call for more “economic stimulus” sound or just more Keynesian nonsense from statists and their court jesters?
Most calls for economic stimulus are based on the so-called ”multiplier effect.”
John Maynard Keynes believed that spending (consumption) was the engine of economic activity. A dollar spent, he opined, would ripple through the economy creating new wealth worth many times the value of the original dollar. He called this the “multiplier effect.”
It is suppose to work something like this:
Joe is given $100. Joe is in the habit of spending 90% of his income, saving the rest for a rainy day. Joe buys a new coat for $90. The shop owner Max, from whom he bought the coat, now has Joe’s $90, but he too is in the habit of spending 90% of his income, saving the rest. Max spends $81 (90% of $90) taking his wife out to dinner. The restaurant owner Mario now has $81 to spend. Like Joe and Max, Mario spends his income, buying various items for $72.90 (90% of $81) for his restaurant at the local hardware store.
This chain of buying and selling continues until someone spends the last dime. According to Keynes’ multiplier, Joe’s $100 increased the wealth of society by $1,000 (ten times $100). Put another way, the value of all goods and services in society increased by $1,000 as a result of the chain of buying and selling started by Joe.
What would happen if the savings rate jumped to 20 percent?
The multiplier would be only half as much, and each new dollar of income would create $5.00 in new found “wealth.” Joe’s $100 would increase the value of goods and services bought and sold in society by only $500. The multiplier effect is the reciprocal of the demand for money, or rate of savings. In this case, 1 divided by .20, or 5.
In the Keynesian view, therefore, the act of saving must be discouraged if the general goal is to increase production and reduce unemployment. As a result, frugality is labeled “hoarding.” Not a good thing. On the other hand, government profligacy is good -- at least when the government needs to stimulate the economy.
With the magic of the multiplier effect dancing in his head, Keynes came to the rather novel conclusion that all that is necessary to cure economic depressions and unemployment is for the government to print and spend money. Keynes wrote (with obvious contempt for market-based economic theories) as follows:
If the Treasury were to fill old bottles with banknotes [fiat paper money], bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again . . . there need be no more unemployment and with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.#
And what can we reasonably conclude from this statement?
We can conclude that the most influential economist of the 20th century did not know beans about the value of money!
Why bother hiding banknotes in old bottles? Do away with the charade and give everyone a printing press so we can print our own banknotes. Everyone will be busy counterfeiting money until all hours of the morning. We will have solved the problem of unemployment, idleness, and scarcity in one fell swoop, and become millionaires in the process. How’s that for economic stimulus?
Of course, this is but a fairy tale. You cannot print your way to wealth and economic prosperity. Wealth does not lie in the amount of paper money floating around the economy, but rather in the available supply of goods and services. An increase in wealth is made possible by technological innovations, which result in more efficient uses of scarce resources. Society is more prosperous when more and better goods and services are available at prices people can afford to pay. By Keynes’ standard, Greece should be rich, while Canada should be well on its way to the poorhouse!
As Jean Baptiste Say pointed out, “commodities are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.”#
The creation of new money out of thin air will not increase society’s real wealth. The effect of more fiat money has more to do with illusion than reality. People will have more money to spend, but they will soon discover that their money buys less. And when the multiplier runs its course, society will find that the placing of new banknotes in old bottles was just another government con game.
Posted by: Stephen C. Apolito | June 29, 2010 at 09:19 PM