What is the Keynesian multiplier?


The Keynesian multiplier was introduced by Richard Kahn in 1930-ies. It showed that any government spending brought about cycles, growth in employment and prosperity regardless of the cost. For example, a $ 100 million government project, whether to build a dam or dig and refill a giant hole, can pay $ 50 million in net cost of labor. Workers then take that $ 50 million and, minus the average saving rate, spend it on different enterprises. These businesses now have more money to hire more people to make more products, leading to another round of spending. In short, a dollar of public spending will generate more than a dollar of economic growth. This idea lies at the basis of the new course and growth of public welfare.

Taken further, if people do not save anything, the economy will stop the motor operating at full employment. Keynesians like tax savings to entice people to spend more. In the Keynesian model arbitrarily separated private savings and investment into two separate functions, showing savings as a leakage in the economy and thereby making them look inferior to deficit spending. But if someone keeps his or her savings completely at the cashier – really hoarding, as it is rarely – savings is actually investing, either in-person or Bank holding company capital.

Milton Friedman, among others, showed that the Keynesian multiplier was incorrectly formulated and fundamentally flawed. One drawback is ignoring how governments Finance spending: taxation or debt problems. Raising taxes takes the same or more out of the economy as savings; raising funds bonds forces the government to go into debt. The growth of debt becomes a powerful incentive for governments to raise taxes or inflate the national currency, to pay, thereby reducing the purchasing power of each dollar workers earn.

(For more, read free market Maven: Milton Friedman)

Perhaps the biggest drawback, however, ignores the fact that savings and investment have a multiplier effect at least equal to the deficit spending, without reducing the debt. In the end, it boils down to whether you trust individuals to spend their money wisely, or you think the officials will do a better job.

For more information, see can Keynesian Economics reduce the cycles of Boom and bust?

This question was answered by Andrew Beattie.

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