You what? Balanced Budget Multiplier?

Eh?

In December, I wrote about the concept of the balanced-budget multiplier and of raising taxes and government expenditure by the same amount, dollar for dollar…, such a policy would be one-for-one expansionary…

Yer what?

Because of the multiplier effect, it is possible to change aggregate demand (Y) keeping a balanced budget. The Government increases its expenditures (G), balancing it by an increase in taxes (T). Since only part of the money taken away from households would have actually been used in the economy, the change in consumption expenditure will be smaller than the change in taxes. Therefore the money which would have been saved by households is instead injected into the economy, itself becoming part of the multiplier process. In general, a change in the balanced budget will change aggregate demand by an amount equal to the change in spending.

Eh?

People are actually serious about this?

That people spending peoples\’ money in Friedman\’s fourth manner (other peoples\’ money on other people) will increase general wealth than people spending money in Friedman\’s first manner (their own money on themselves).

Seriously? No, really, I mean seriously, macroeconomics has got so far up its own arse that people actually suggest that this is possible?

Jeebus.

22 comments on “You what? Balanced Budget Multiplier?

  1. Dear me, Tim, I thought you were interested in mining Scandium, not nonasense like this; for a moment, I thought I was reading dear Ritchie, but I see it’s Shiller. I’m sure Ritchie agrees, though…

    It’s actually terrifying.

  2. so someone is now saying that tax revenue would not have been used elewhere in the circular flow, either as investment or consumption? This looks like the new macro we have all been waiting for.

  3. Long time since I looked at this theory, but I seem to remember finding it plausible. Part of the argument was that individuals would have spent some of their income on imports, which would do nothing for domestic employment, but the government would spend the same money within the national economy, thus providing an injection of funds. Multiplier effects would occur in the normal way and national income would, indeed, rise.

    Does it actually work like that? I dunno.

  4. “Since only part of the money taken away from households would have actually been used in the economy…”

    And the rest would have been what? Burnt? Turned into compost?

  5. “but the government would spend the same money within the national economy,”

    Ah. The P word…

  6. Glenn: The logic isn’t related to exports and imports.

    View from the Solent: In theory, it would be saved, but NOT lent back out as investment.

    The theory runs like this:

    Let’s say that the economy is performing below capacity. Capital and labour are not fully utilised. On getting a pay check, some people will save (rather than spend) some of the money, depositing it in their bank account (a few might even just put it under their mattress, afraid that the banks might fail). And upon receiving a deposit, and deducting the reserve percentage, some banks will be unable to lend out all of the balance, because businesses – finding current production lines already idled – are not investing. And because they have idled production lines, they have also made a lot of workers redundant, making all workers less likely to consume. As a result, we see low GDP, high unemployment, high bank reserves, low investment, and low (or negative) growth.

    I’m not saying that the world is currently like that, nor that it has ever been like that, nor that it COULD be like that. But just imagine that this is, in fact, a description of the world as it is.

    Now, if we were to come, take all the money sitting idle in bank accounts, and spend it by hiring an army of people to create a 1:1 scale replica of London out of matchsticks in the middle of the Sonora Desert (or something equally foolish), we would – arguably – see GDP rise, unemployment fall, investment increase (from match manufacturers building more capacity, if nothing else), and so on.

    That’s really the entire point of Keynesian stimulus. The idea of a “balanced budget multiplier” is inherent in the idea that the government can commandeer idle factors of production, force them to be utilised (even in pointless, wasteful ways), and realize an increase in GDP. It’s the fundamental idea behind Keynesian macroeconomics, and it’s focus on aggregate demand.

    It may not apply to any given situation (or indeed, any situation at all). Perhaps aggregate demand can’t get “stuck” at a lower level. Or if it can, perhaps government intervention can’t raise it. Or if it can, perhaps our governments, in the here and now, cannot do so due to political constraints. But the idea itself isn’t crazy.

  7. Cody is correct.

    Demand isn’t just demand for goods that are components of GDP. That is, demand isn’t just demand for output. It can also be demand for existing things such as money and existing capital.

    That is what the people Krugman calls “Part 1 Keynesians” are worried about. The point is this, if I tax a dollar from Tim Worstall that means that he can’t spend the dollar on biding up the price of shares in Google. Any income may be spent partly on output and partly on existing goods, Keynesians are worried about the probability that it will be spent on existing goods. If the dollar is taxed from Tim Worstall it means (theoretically) that all of it will be spent on components of output and non will remain as a money balance or to drive up the cost of non-reproducible goods. (And Keynesians would include in that later category any good that can’t be made in the short-run. So a ford car is a reproducible good, but the ford motor company is a non-reproducible good).

    This theory has been going around in Keynesian circles since the 50s at least. If you believe Keynesianism then logically it follows.

  8. Everyone is aware that there is no multiplier effect, right? I mean, not that there is some argument about its magnitude, but that there simply is no multiplier. It doesn’t exist. It’s a mathematical fallacy. Right?

  9. It’s got so inside the national psyche though that it’s taken as a given. You pay and I decide where the money goes, though I’m totally unqualified to do so and on a fat salary and kickbacks.

  10. Cody, good answer.

    IanB, I don’t believe in the multiplier effect, it always struck me as mathematical nonsense, even though my economic lecturer told me (mid 1990s) with an absolutely straight face that there was such a thing.

    But it would be interesting to see how many people do.

  11. Ian B: We are not aware of this, because it is not true. Of COURSE there is a multiplier. It exists by definition. If the government buys $10 of widgets, GDP changes by some number. It might go up by $10 (ie, multiplier of 1), or more than $10 (ie, greater than 1). Or it might go up by less than 1 (ie, less than 1), or not even change (ie, multiplier of 0). Hell, GDP might even go down (ie, negative number). But GDP is going to do SOMETHING (up, down, or stay the same), and every option yields a value for the multiplier.

    To claim – as you do – that the concept of a multiplier is a “mathematical fallacy” implies that you may not understand some of the concepts involved. Like “multiplier”, or “fallacy”. Perhaps you’re trying to suggest that the multiplier is always 1? Or 0? Both of those positions would be wrong, but at least they’re not nonsense.

    In any case, the actual point of debate is on the value of the multiplier. Keynesian theory says a lot about how we might exploit highly positive multiplier (it, greater than 1), but has less to say about when – if ever – the multiplier actually will be greater than 1.

    For that, we have to turn to empirical research, which tells us the multiplier is very small (indeed, approaching zero) for heavily indebted countries, small countries, open countries, or countries with floating exchange rates. And if the multiplier isn’t greater than 1, then Keynesian stimulus will not – even according to Keynesian theory – work.

    (Note: Every western country falls into one or more of these categories. Which is why so much of what Krugman writes these days is so pointless. It’s like listening to theologians debating how many angels can fit on the head of a pin. It’s undoubtedly interesting to them, but it could scarcely have less relevance to the world we find ourselves in.)

  12. I’m wondering how Cody’s model of London in Arizona can contribute to GDP when nothing is actually being produced, when the result has no market value. Perhaps someone can explain.

  13. @Ian Bennet: Exactly All that stimulus has created a massive match model building industry, with supply chain to match, and its all useless, and has no link to what real people want to spend their own money on. Thus once you’ve started it, you have to keep it going on subsidy for ever or the whole thing collapses the moment you stop pouring the tax in.

    The only way Keynesianism can have ANY long term positive effect is if you use the money to make something useful – a high speed fibre optic system, or a new motorway network, or increased rail capacity.

    Then when the stimulus stops there is something useful for the rest of the economy to use and promote growth and new markets.

    Paying people to dig holes and fill them in makes work for the time it takes, then you are back to square one. There may even be negative effects as the dislocation of resources from productive industries has prevented real growth elsewhere.

  14. “I’m wondering how Cody’s model of London in Arizona can contribute to GDP when nothing is actually being produced, when the result has no market value. Perhaps someone can explain.”

    Because the contribution of the public sector to GDP is measured at cost

  15. Cody, there cannot be a multiplier. I sometimes consider an annual prize competition for the shortest demolition of the silly idea.

    The “multiplier” is not merely an increase in GDP. I’m sure you know that. GDP is a measure over some arbitrary time period, and as such whatever multiplier you might get is purely proportional to the time peirod. In that case, what you are pretending to be a “multiplier” is already accounted for. It is the money velocity, V. It is the same for every groat regardless of its origin- government spending, private spending, piggy bank raiding.

    Nobody means that by the term “multiplier”. They mean that one starts with a groat, and it has the effect of multiple groats in the economy. That is what Keynes meant, and what is meant by modern Keynesians.

    And it does not exist.

    How do we know that? There are so many ways, but it occurred to me recently that one easy way to demonstrate it is that money is fungible. THere is no way for the economy to know whether a groat is a state spending groat or a private groat or a piggy bank groat. As such, either all groats multiply, or they don’t.

    If they do, it is obvious that the number of groats would rise exponentially, because each multiplied groat becomes the start of a new multiplication cascade.

    They don’t do that. The “multiplier” is 1. That is, it is a nonexistent factor.

    Sorry. You’re talking crap.

  16. Because the contribution of the public sector to GDP is measured at cost

    Indeed. The GDP figure as measured is almost useless.

  17. And there’s no such thing as “deficient demand” either. We all want better gadgets, fluffier towels, flatter bellies. Sometimes we’re not prepared to work for these goods, but to suggest that we don’t want them and so the government must give them to us anyway (by the Keynesian multiplier) is sheer nonsense.

  18. Current: if I tax a dollar from Tim Worstall that means that he can’t spend the dollar on biding up the price of shares in Google.

    But if Tim spends an extra $1 on shares in Google, then the seller of the share must have an extra $(1-T), where T is the transaction costs, including brokers’ fees and taxes.

    So for money going into assets to be unproductive requires some theory as to why the sellers of assets (and any brokers and land surveyors and what not who are paid from the transaction) would be less likely to spend or invest that money than the buyers.

    The problem as I understand it of deficit demand arises from people wanting to just stash that money under the mattress, not wanting to spend it on assets.

  19. Ian Bennet: As others have explained, GDP is by definition Y = C + I + G + (X ? M), where G is government spending. And it’s no good saying that G shouldn’t count; another – equally valid – definition of GDP as the sum of interest, profits, and wages. All government spending ends up as one of those, and if you don’t count it your figures won’t balance. And as Ian B says (quite rightly), money is fungible. Wages are wages, whomever pays them.

    Ian B: You don’t appear to understand the theories you cite; once we strip out your confusion you aren’t really disagreeing with me or the elements of orthodox Keynesian economics I just summarized. The main issue You’re trying to use monetarist terms (ie, velocity), rather than Keynesian terms (ie, multiplier). But both are talking about the same concept, just expressed in different ways: “Are people consuming, investing, or hiring…or not?” Yes, the velocity of money is EXACTLY what we’re talking about. The idea behind Keynesian theory – expressed in monetarist terms – is that given the equation of exchange (MV = PT) we can boost T (real GDP) by exogenously boosting V. And sure, that could happen…in theory. But as a practical matter, it won’t.

    (If it helps, consider: A Keynesian says “since the multiplier is 2.4, if I spend this $1 now, it will cause an addition $1.40 in spending, and will have a total impact on GDP of $2.40”. A monetarist says “since the velocity of money is 2.4, if I spend this $1 now, the dollar will change hands an additional 1.4 times, and will have a total impact on GDP of $2.40”. These are rather…similar formulations, no? And indeed, they have to be. Over any given period, the multiplier IS the velocity.)

    Beyond that…no, the multiplier isn’t 1 (certainly not always). Yes, all money has some velocity. No, it’s not the same for all money at any one time. Velocity summed over time is essentially the Keyenesian multiplier. Yes, all money has a multiplier effect. No, Keynesian don’t think there’s something magic about government spending; just that it’s easier to force government to spend than to force businesses to invest or consumers to consume. And no, the fact that money has a velocity doesn’t mean there’s an infinite amount of money in circulation.

    (Oh – and lastly: Can you imagine a situation where the government goes and paves the underside of some lakes, and people got so stressed out about government debt that GDP ended up LOWER than it otherwise would have been? You can? Great, now you too understand why the multiplier can be lower than 1 – and so is not, as you claim, a “nonexistent factor”. Or if you can’t imagine that, go check out Japan and be amazed at the breadth of human ingenuity when it comes to throwing money down rabbit holes.)

    blokeinfrance: Cash is a good like any other. In times of crisis we may up our demand for cash, and lower our demand for other goods. Outside the world of economics we call this “not being a dumbass”. Still, it undeniably has effects on the economy at large. Just look at the figures for spending and investment in the US or UK over the past couple of years!

    Now, it may be that government shouldn’t respond to this by FORCING people to consume. (I would agree!) It may even be that governments, as a practical matter, CAN’T force to consume, as people (not being dumbasses) can see what’s going on, and will respond by increasing their demand for cash (along with canned goods, precious metals, and ammo). This may be so even if governments try and get tricky by borrowing money to fund current consumptuon. (I would agree with this too!) But what I can’t agree with – because it’s obviously wrong – is that people don’t respond to event like the global financial crisis by – among other things – cutting back on their purchases of new gadgets and fluffy towels. They do. (And rightly so.)

  20. I pretty much agree with Cody here. Though I disagree with some of his details.

    Tracy wrote:
    “So for money going into assets to be unproductive requires some theory as to why the sellers of assets (and any brokers and land surveyors and what not who are paid from the transaction) would be less likely to spend or invest that money than the buyers. ”

    That’s right. If the sellers decide to spend their money on output or investment in the same period then no GDP is lost. However, if they decide to spend in bidding up the price of existing goods then the same problem occurs that I describe.

    In this situation the “multiplier” is really about how much time it takes for an act of saving to lead to spending on output. That’s the relationship to monetarist velocity that Cody mentions.

  21. Jim-
    Another way to state this-“Then when the stimulus stops there is something…” that requires huge inputs in O&M for which there is no source of funds as the utilization was wildly over-estimated in order to justify the initial costs.

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