Keynesian Skepticism

by Sal on January 15, 2009

in Economy,Politics

Economist N. Gregory Manikiw, a Professor of Economics at Harvard and former advisor to the Bush administration, has a piece at the New York Times today about the economic multiplier effect first posited by Keynes and popularized Paul Samuelson, author of early Economic textbooks.  In the piece, Manikiw examines the gap between the relative effectiveness of government spending vs. tax cuts as an economic stimulus. On government spending:

Economics textbooks, including Mr. Samuelson’s and my own more recent contribution, teach that each dollar of government spending can increase the nation’s gross domestic product by more than a dollar. When higher government spending increases G.D.P., consumers respond to the extra income they earn by spending more themselves. Higher consumer spending expands aggregate demand further, raising the G.D.P. yet again. And so on. This positive feedback loop is called the multiplier effect.

In practice, however, the multiplier for government spending is not very large. The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States’ historical record, Professor Ramey estimates that each dollar of government spending increases the G.D.P. by only 1.4 dollars. So, by doing the math, we find that when the G.D.P. expands, less than a third of the increase takes the form of private consumption and investment. Most is for what the government has ordered, which raises the next question.

Tax cuts, however, despite the Keynesian claim to the contrary, actually has a triple-multiplier effect:

Textbook Keynesian theory says that tax cuts are less potent than spending increases for stimulating an economy. When the government spends a dollar, the dollar is spent. When the government gives a household a dollar back in taxes, the dollar might be saved, which does not add to aggregate demand.

The evidence, however, is hard to square with the theory. A recent study by Christina D. Romer and David H. Romer, then economists at the University of California, Berkeley, finds that a dollar of tax cuts raises the G.D.P. by about $3. According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases.

Why this is so remains a puzzle. One can easily conjecture about what the textbook theory leaves out, but it will take more research to sort things out. And whether these results based on historical data apply to our current extraordinary circumstances is open to debate.

As demonstrated here and previously, Keynesian economics has been debunked over and over again.  Yet the Democrats continue to insist that it is the solution to our economic woes.  Manikiw argues that congress should take a step back and go with proven economic evidence rather than bunked theories.

{ 2 comments… read them below or add one }

Ron Russell January 15, 2009 at 4:08 pm

During the recent election B.H.O. gave us all a lot of “bull shi….t”, and most readily cobbled it up. I understand they are eating cow pooph in Zambawee now thanks to the efforts of Mugabe’s form of African Keynesian. It worries me that Chief Obama’s roots are in neighboring Kenya and that he is also a socialist. We ate his bullshi…t so are we now headed toward a form of Kenyian Keynesianism where “barnyard cake” will be at the top of the menu. What a mouth full.


Micha Elyi January 17, 2009 at 6:55 pm

I wonder if much of the discussed multiplier effect paradoxes are due to misunderstandings of what G.D.P. measures. Spending a dollar filling America’s money hole does not produce economic consequences comparable to spending a dollar satisfying an individual consumer’s wants.


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