The multiplier is how much econ activity results from a unit of government spending. E.g: GDP change = M * G. Most Kenysians and modern economists argue that under some macro conditions X$ of government spending can produce more or less than X$ of GDP/economic value. Specifically in recessions. This means that gov “stimulus” or spending during a recession is good. I’m confused by the explanations I’ve read. Let’s lay out the explanation the problems I see with it.
The conventional explanation for the multiplier goes something like this
Imagine a country in normal times. The economy is near full employment. Factories are humming along. Most money that can be profitably invested, is. In a situation like this if the government spend X$ of money on a new program, say building a dam, it won’t necessarily generate X$ of new economic activity/GDP. Why? Because the workers who are hired to build the dam are now doing that instead of working on some project in the private sector. The concrete and other raw inputs are likely being taken away from the private sector. (In an aggregate/diffuse “higher demand raises prices slightly, crowding out other uses” kind of way). Even the money used to pay for the project is taken away from taxpayers who would have in turn spent it on other goods and services. In other words the gov generated econ activity trades off against or “crowds our” private sector econ activity.
(N.B: This doesn’t mean that it’s always bad/zero-sum. You can imagine cases where gov spending is much better than private spending, e.g: because the gov has investment options the private sector doesn’t (e.g: public goods, defense, etc…).)
Now imagine the reverse. Sometimes an economic downturn happens. During a downturn, a lot of physical infrastructure/resources go unused. Workers are unemployed, sitting at home instead of making things. Factories are mothballed. People sit on their money instead of spending it. All these things put together mean that the economy is operating at less than it’s max sustained capacity. In a situation like this government spending may generate more economic activity in aggregate. Why?
Okay. Now the problems.
1: “Workers will spend their wages on good produced by other people” True but also true of all spending of money for any purpose. This isn’t a “multiplier” specific to gov spending. It’s a ‘multiplier’ which applies to anyone getting money for any reason. It obviously applies to a private sector worker who is also paid wages and will also use those wages to buy things. It applies to investment. A consumer saves from the bank. The company then spends $X dollars on goods and services. It applies even to raw saving. A consumer burns $X in a bonfire. The supply of money has gone down slightly. Now the value of money for everyone else goes up slightly. This leads to $X of more spending/value.
This feels a bit lake a bait and switch. It is obviously a multiplier. It’s not the same “multiplier” people talk about when they talk about why gov stimulus during a recession is good.
2: Using up spare capacity The logic here is that by spending government money, you’re putting “idle” resources to work. But I’m still confuzzled here. The $$$ they government spend on a program must come from somewhere. Assuming a closed system, it’s either from taxation or from inflating the currency. So for every dollar spent by gov, a dollar has been taken away from the private sector. So isn’t there still a tradeoff here? e.g: If the government spend $100 million to build a hospital, wouldn’t the private sector have spent the same money to build something else instead?
The few cases where I can see the hints of a justification are
Taxing consumers with a lower propensity to spend and giving money to ones with a higher propensity = more spending Expectation traps. Something like everyone expects low demand => everyone cuts spending to save => Demand becomes low in reality. But I have a few problems with these models. In terms of consumer spending and marginal propensity to consume why does a consumer spending or saving more matter? Saving by one party is inevitably just spending by someone else. “Saved” money doesn’t magically disappear. Even if it did, that would just raise the value of all money slightly and basically be equivalent to that person giving away their funds to everyone else. I’m also vaguely uncomfortable with the expectation trap angle. The rational is that by forcing spending, the gov can break a self-sustaining cycle of low demand expectations and hence prompt growth. I have a few questions about this:
I recognize that I am confused here. Talking to ChatGPT helped but yeah. I think I get the basic case for stimulus. I think I also get the basic critique. I don’t yet understand how sticky prices play into this and I have a feeling that that’s a crucial part of the puzzle.