John employment and prosperity, no matter what kind

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John Maynard Keynes: Multiplier EffectIn 1931, a British economist named Richard Kahn introduced what is known as the multiplier effect. In Kahn’s article, “The Relation of Home Investment to Unemployment”, he first introduced the multiplier effect which in turn ended up being his most notable contribution to the field of economics (“Richard Kahn, Baron Kahn.”). The multiplier effect can be defined as how aggregate expenditure, for example government spending, causes an increase in output. According to Investopedia, the multiplier effect showed that any type of government spending results in cycles that increase employment and prosperity, no matter what kind of spending it is Beattie, Andrew). With that being said, how much money should the government put into the economy? When does it get to the point where debt and taxation begin to hurt us more than help us? Richard Kahn and John Maynard Keynes became acquainted with one another while attending Cambridge to discuss questions like these. Keynes analyzed Kahn’s multiplier effect to determine his own opinion and derivation of the multiplier effect. Today, Keynes takes most of the credit for the ideas originally brought forth by Kahn because they tend to be more accurate. In the United States, we have recently seen how Keynes’ ideas have been used to pull the country out of recessions, such as the housing crisis of 2007-2008. At Cambridge University in 1931, a group of men consisting of Richard Kahn, John Maynard Keynes, and five others came together to discuss economics. This group was known as the Cambridge Circus. These men met and worked with Keynes to provide feedback on his work that led to his publication of “General Theory of Employment, Interest, and Money.” This book written by Keynes was undoubtedly his most notable work and contributed to the actions the US took to get out of the Great Depression. Not only did this work introduce importance concepts of the consumption function, the marginal efficiency of capital, the principle of effective demand and liquidity preference, but it also introduced Keynes’ analysis of the multiplier (“The General Theory of Employment, Interest and Money.”). Although Keynes passed away in 1946, he is considered arguably the most influential economist of the 20th century and event today we continue to see some economic ideas originated from Keynes.  The primary concept surrounding the multiplier is that once money is filtered into the economy, people will continue to spend that money. Theoretically, if people saved no money, by Keynesian Economics, the economy would be a perfect, unstoppable engine running at full employment (Beattie, Andrew). Unfortunately, people do save money and the economy isn’t perfect. Keynesians argued that the more that the government can get people to spend all of the income, the closer to perfection the economy would be. With that being said, Keynesians attempted to counteract savings by taxing savings. This would ultimately cause more people to spend their money rather than save it, because why would people save if they have to pay to save?Keynes’ defined the multiplier to be 1/(1-MPC), where MPC stands for the Marginal Propensity to Consume. Although, what does “Marginal Propensity to Consume” mean? When a person gets money, let’s say $500, the person will either spend that money or save that money. The rate of how much the person spends is the Marginal Propensity to Consume. So, if the person spends $450, that means that essentially they save $50, because it is assumed that all of the money is going towards either saving or spending. Mathematically, the rate of which the person consumes, is $450/$500. This equates to .9. By the definition that Keynes derived, the multiplier in this situation would be the following: In this case, the multiplier is 10. It is important to note that MPC+MPS=1. This equation simply means that all of one’s income will be put forth to consuming or saving. With this equation, the multiplier effect can also be written as 1/MPS. The following picture shows an idea of what happens to a dollar filtered into the economy. In this scenario, the MPC is .5, so each period takes off half of the previous period. During the financial crisis of 2007-2008, Barack Obama and the United States needed to find a way to escape the recession. This crisis led to a re-awakening of Keynes’ ideas of the multiplier. Barack Obama wanted to boost America’s economy by putting into effect a “fiscal stimulus package.” This would pump in over $800 billion dollars into the US economy. While some economists thought this was a bad idea, some thought it would be beneficial because they believed in the multiplier developed by Keynes. Keynes would have argued that the $800 billion would in turn end up being more beneficial than just $800 billion. If this money was pumped into the economy, then the people who receive that money would then spend and the money would continue to cycle into the economy. Of course, consumption dipped during this time because people were scared to put money into the economy, and therefore saved. Although, if we assume that people spent approximately 75% of their income earned during 2008, we can compute how much the $800 billion would help the economy by the following: Through Keynesian economics, under the assumption that at the time of the recession the Marginal Propensity to Consume is .75, then through the multiplier effect, $800 billion would have worth of approximately $3.2 trillion in the economy. This stimulus package that Obama outlined was approved by congress in February of 2009. So the big question is, was this package a success? It is tough to give a firm answer to this question, but many people believe that this package was a failure because the economy contracted 2.8% in 2009. On the other hand, from February to October, the stimulus bill saved over 600,000 jobs. Kimberly Amadeo, a writer for The Balance, said “Overall The aid helped, but many states were so underwater that their losses outweighed the federal assistance.” (Amadeo, Kimberly) The graph below shows the countries in the world that have the highest average propensity to consume. Clearly, we can see that even though there are four countries above the US, the average propensity to consume of the United States tends to be much higher than other countries. It is interesting to see that Denmark’s APC is above one. How can this be possible? According to The Economist, “For an economy operating at full capacity, the fiscal multiplier should be zero. Since there are no spare resources, any increase in government demand would just replace spending elsewhere. But in a recession, when workers and factories lie idle, a fiscal boost can increase overall demand. And if the initial stimulus triggers a cascade of expenditure among consumers and businesses, the multiplier can be well above one.” (“Much ado about multipliers.”) Even though this model was created in 2012, the data to this day is still similar. It is important to note that the average propensity to consume differs from the marginal propensity to consume. Why is the MPC higher for the United States vs. the rest of the world? Sean Ross, the Director of Business Development at Financial Poise and a frequent contributor to Investopedia, said “Since the US dollar is a de facts reserve currency for many central banks, Americans can essentially trade dollars for cheap foreign goods without ever having to produce an equivalent amount of goods in return. This means American savings rates can be artificially low.” Economists and statisticians estimate the marginal propensity to consume in the United States also tends to be higher than many other countries as well. In fact, they estimate that in the US, the MPC is somewhere between 90% and 98%. Using this information, it is possible to create a lower and upper bound for the current multiplier for the United States. The mathematical work above proves that the multiplier for the United States lies somewhere between 10 and 50. Of course, this is under the assumption that the marginal propensity to consume in the United States is within the range of 90% to 98%. P7: Clearly, there must be an incorrect assumption or contradiction when it comes to the multiplier effect, or else the government would continue to spend more and more money into our economy. This would theoretically result in a perfect economy with no unemployment, which is impossible. One economist who analyzed the Keynesian multiplier and denied it was Milton Friedman. Friedman was the closest competition to Keynes for the most popular economist of the 20th century due to his contributions in consumption analysis, monetary history and theory, and the complexity of the stabilization policy (“Milton Friedman”). He also became the main advocate against Keynesian government policies. The following paragraph from Investopedia explains how flaws play into the multiplier: “One flaw is ignoring how governments finance spending: taxation or debt issues. Raising taxes takes the same or more out of the economy as saving; raising funds by bonds causes the government to go in debt. The growth of debt becomes a powerful incentive for the government to raise taxes or inflate the currency to pay it off, thus lowering the purchasing power of each dollar that the workers are earning. Perhaps the biggest flaw is ignoring the fact that saving and investing have a multiplier effect at least equal to that of deficit spending, without the debt downside. In the end, it comes down to whether you trust private individuals to spend their own money wisely or whether you think government officials will do a better job.” (Beattie, Andrew)P8: Conclusion”The General Theory of Employment, Interest and Money.” Wikipedia. December 21, 2017. Accessed December 22, 2017.,_Interest_and_Money.”Richard Kahn, Baron Kahn.” Wikipedia. December 21, 2017. Accessed December 22, 2017.,_Baron_Kahn.Beattie, Andrew. “What is the Keynesian multiplier?” Investopedia. August 27, 2009. Accessed December 22, 2017., Sean. “How does the marginal propensity to consume in the United States compare to other countries?” Investopedia. June 04, 2015. Accessed December 22, 2017. “Milton Friedman.” Wikipedia. December 22, 2017. Accessed December 23, 2017. “Much ado about multipliers.” The Economist. September 26, 2009. Accessed December 23, 2017. Amadeo, Kimberly. “Did Obama’s Stimulus Plan Work?” The Balance. Accessed December 23, 2017.

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