Oh dear, trouble for t\’multiplier

Now then, now then. this is something of a spanner in hte works for that lovely traditional Keynesianism that billions of our money are being spent upon.

Everything depends on the size of the multiplier. Trust me on that one, OK?

A low multiplier (or heaven forfend, a negative one) means we shouldn\’t do the stimulus spending. A high one means perhaps we should. So, does the UK have a high or a low one?

The degree of exchange rate flexibility is a critical
determinant of the size of fiscal multipliers.
Economies operating under predetermined
exchange rate regimes have long-run multipliers
of around 1.5, but economies with flexible
exchange rate regimes have essentially zero multipliers.

We\’ve a flexible exchange rate, as the bouncing pounds shows. So we\’ve got a low multiplier.

The degree of openness to trade (measured as
exports plus imports as a proportion of GDP) is
another critical determinant.1 Relatively closed
economies have long-run multipliers of around
1.6, but relatively open economies have very
small or zero multipliers.

Their definition of open is if imports plus exports is more than 60% of the economy. No, for the UK this isn\’t quite true.

But we do have a flexible exhcnage rate, so perhaps fiscal stimulus won\’t work and thus we shouldn\’t be doing it?

One way of looking at this might be as with tax incidence but in reverse. Capital taxes can only be shed by capitalists onto others if it\’s an open economy: maybe Keyneisanism only works in a closed(ish) economy with fixed exchange rates? Actually, in something like the economy that Keynes was writing about?

13 comments on “Oh dear, trouble for t\’multiplier

  1. “Economies with flexible exchange rate regimes have essentially zero multipliers.”
    Surely, it depends upon the exchange rate response to the stimulus? If the stimulus leads to a rise in the exchange rate (as in Dornbusch-style models) then this indeed crowds out the fiscal boost, leaving us with a low or even negative multiplier.
    But this did not happen with the UK’s stimulus last year – if anything the opposite.

  2. I just love the way the neo-Keynesian quote the multiplier effect to two-decimal places. From memory 1.57 which makes it look so much more believable. 😉

  3. That Keynesian works best in a closed economy is the reason a lot of people think he was writing his book about the US Depression, isn’t it?

  4. Um, Tim, this is an abstract model. It happens because the exchange rate rises, and crowds out the government spending, thereby negating the effect of the G through lower X.

    Check out a graph of EURGBP some time.

    Incidentally, G Osborne is also relying on the same effect (when we cut spending, a weaker pound is going to make all the difference). So one year, warning of a sterling crisis, next year needing one.

    I’m afraid you conservatives are all over the place on this one, and selective googling will not make up for it.

  5. Dear Tim

    hte letters on your keyboard are not welded on.

    You could easily solve an, admittedly minor, irritation on your otherwise excellent site by prising off hte T and hte H and swopping them over…

  6. “Nevertheless the theory of output as a whole, which is what the following book purports to provide, is much more easily adapted to the conditions of a totalitarian state, than is the theory of production and distribution of a given output produced under conditions of free competition and a large measure of laissez-faire.”

    J.M Keynes, Collected Writings P. xxvi

  7. The multiplier is a joke, of course.

    It may be true (unlikely but possible) that the government can splurge £1 and increase economic activity by £1.50, in which case is can splurge £1 billion and increase economic activity by £1.5 billion. But what it is splurges £1 trillion?

    No way would the multiplier that applies to that £1 trillion be the same as the one that applied to the £1 billion or £1.

    PS, what on earth do you mean when you say “Capital taxes”? Do you mean taxes on profits?

  8. Mark

    You haven’t shown that the multiplier doesn’t work. You have merely demonstrated that it is probably a differentiable function with a first or second derivative that causes its effect to lessen as the stimulus grows. That is not only true for multipliers, but also for the Laffer style cuts that the Right likes. Cutting taxes from 90% to 70% raises money. But not from 20% to 10%.

  9. “it is probably a differentiable function with a first or second derivative”

    which is a smart-arse way of saying the effect is non-linear, in which case a scalar like ‘the’ multiplier is silly. And if it were only billions we were talking about no-one would care.

  10. Actually, for the remaining smart arses: zero second differential implies linearity, zero first differential implies constancy as in y” = 0 ⇒ y = a x + b, y’ = 0 ⇒ y = a (assuming y ∈ ℝ : y → x ∈ ℝ i.e. y is injective in reals and y is well-behaved, yada, yada).

  11. ?

    All I know is borrowing money to invest only works if whatever you invest in generates enough income to repay the debt plus interest (and preferably a bit of profit too).

    Somehow I don’t see Mr Brown’s choice of investment vehicle achieving that. I mean: What’s the ROI of a Real Nappy Officer or an Ethnic Minority Outreach Workshop?

  12. Pingback: That issue again « Freethinking Economist

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