Read the responses, they are equally as interesting as the main article.

  

Sorry, but the fiscal multiplier doesn't multiply

Written by Tim Worstall

Sunday, 20 March 2011 07:00

5 Comments and 1 Reaction Rather a lot of macroeconomics is conducted with models. Given the complexities, this is inevitable, but it is necessary, at least occasionally, to look up and calibrate the model against reality. Which is just what this paper (via Scott Sumner) has just done. For those of a Keynesian persuasion, the results aren't pretty. You see, the central conceit, that government borrowing to spend boosts the economy by more than the amount of the spending, the multiplier, just isn't true. Just isn't true for us here in the UK, that is. The fiscal multiplier just doesn't multiply. ....the impact of government fiscal stimulus depends on key country characteristics, including the level of development, the exchange rate regime, openness to trade, and public indebtedness. Higher development (like us) makes for a higher multiplier. Openness to trade for a lower. These two might, in our circumstances, roughly balance each other out. However: Indebtedness also matters: when the outstanding debt of the central government exceeds 60 percent of GDP, the fiscal multiplier is not statistically different from zero on impact and it is negative in the long run. Hmm, so, UK debt is, end Jan this year, 57.6% of GDP. So, at current borrowing rates we've about 3 months before the effects of deficit spending turn negative. But that's not the end of it: Exchange rate flexibility is critical: economies operating under predetermined exchange rate regimes have long-run multipliers greater than one in some specifications, while economies with flexible exchange rate regimes have multipliers that are essentially zero. The pound is extremely flexible: so none of the fiscal stimulus we've already had has had any effect either. If this paper is correct then that's it for Keynesianism in the UK, into the dustbin of history with it. For if the fiscal multiplier just don't multiply, there's no point to it all at all. It was Keynes himself who remarked that people often find themselves in the grip of long dead economists to the detriment of their ability to do economics: M'Lord Keynes died in 1946. LikeDislike  5 people liked this. Community Disqus Showing 5 comments Sort by             Popular now            Best rating            Newest first            Oldest first             Subscribe by email   Subscribe by RSS Alimac 5 hours ago At last! Glad to have this paper brought to my attention Reminds me of the days when some measured BC as benefits plus costs divided by costs lets have some assessment here by those who can do the Math   Dr. Adrian Wrigley 2 hours ago Of course the Keynesianists are talking nonsense. But a quick look at the paper suggests it is nonsense too, unfortunately. "the impact of government fiscal stimulus depends on key country characteristics" "After analyzing a quarterly dataset on government expenditures for 44 countries (20 high-income and 24 developing) from 1960 to 2007, they conclude that the output effect of an increase in government consumption is larger in industrial than in developing countries." The fiscal multiplier is all about cause and effect. If a government chooses what Keynesianists call "stimulus" to the economy, how would real GDP respond? This is what the paper purports to be about. The paper seems to be about a completely different issue - correlation. Is there any observed relationship between GDP growth and "stimulus". Since we observe that a bad GDP outlook causes demands for stimulus, it seems perverse to infer anything of a possible causal relationship the other way round. Unfortunately I could only read the summary and abstract of the paper, but I assume these fairly represent the main work. When will economists learn "correlation does not imply causation"?   Alimac 2 hours ago Why limit your stricture to economists? Are not most scientists the same including social and medical Among interpreters of Keynes theory more spending increases demand employment and growth but empiical tests raise doubts Just like AGW theory and evidence or smoking and cancer?   facebook-671176264 2 hours ago The more fundamental misconception, which is shared by Keynesians and most Monetarists, is that it is necessary for governments to borrow at all in order to invest in creating productive assets and the productive indiviiduals who create them. Private banks create private credit/money and spend it on developing their business whenever they credit the accounts of suppliers, staff and management. There is no reason whatever, other than ideology, that the Bank of England should not create public credit on behalf of the Treasury and spend it on such investment rather than using it as QE to buy gilts. Provided public credit creation is professionally managed and adequately supervised by a monetary authority then the public credit may be retired and recycled either from taxation or from pension investment in the newly created assets, and there will be no inflation.   Cantab83 1 minute ago "It was Keynes himself who remarked that people often find themselves in the grip of long dead economists to the detriment of their ability to do economics: M'Lord Keynes died in 1946." And Adam Smith died in 1790. I wonder to whom Keynes was referring? You see we can all indulge in cheap political point-scoring. Actually the quote is: "...even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist". On a more constructive note, the problem with discussing Keynes is that most of his ideas and theories are either misunderstood, or applied inappropriately, both by those who claim to support them and by those who vehemently oppose them. Even Keynes would have probably disagreed with most of the fiscal measures that have been enacted in his name over the last half-century.