Wednesday, November 2, 2011

The (Keynesian) Multiplier

Every so often we realize we've been using terms that we understand, but that might cause confusion to people unfamiliar with the basics of the Just Third Way. It's useful, then, to take a step back and see if we can come up with a better explanation, use a better term, or just admit we goofed and correct the mistake. Today it's a little bit of each.

Our mistake was twofold. One, we thought that everyone knew that "the multiplier" is a Keynesian concept. True, the Monetarist/Chicagoans are the primary users of the money multiplier, but it's based on assumptions shared with Keynesian economics, and is, in that sense, Keynesian, and that's how we've been describing it. If Milton Friedman can assert that everybody [in his opinion] is a Keynesian, we can agree with him that, in a sense, everybody within the Currency School is [in his opinion] a Keynesian.

Two, we thought everyone knew that there are three general categories of "the multiplier." They're all related, and they're all in a sense Keynesian, but the specific term is different for each one. There is, one, the money multiplier, two, fiscal multipliers, and three, the Keynesian multiplier proper. We've been using "the Keynesian multiplier" to describe the "money multiplier" because it's Keynesian. This has caused some confusion, especially among people who aren't aware of the fabricated intricacies of fractional reserve banking.

The bottom line here is that "the multiplier" encompasses a number of concepts, not just one, and, while "the multiplier" is a Keynesian concept in general, one of the particular concepts under the general heading of "the multiplier" is "the Keynesian multiplier," also known as "the [government] spending multiplier."

To see if we can eliminate some of the confusion, in the future we will try to use "money multiplier" to describe the erroneous theory of how fractional reserve banking allegedly increases the money supply, "fiscal multiplier" to describe those theories that try to describe the effects of government fiscal policy, and "the Keynesian multiplier," a type of fiscal multiplier, to describe how changes in government spending allegedly affect GDP.

All the multipliers share a common error, and since it is an error that is fundamental to Keynesian economics, we've been a little loose with our terminology. The error is the Currency Principle, common to Monetarist and Austrian economics, that "money" consists of coin, currency, demand deposits and some time deposits, and that it only represents existing wealth of the economy. Still, because the multiplier is a key component of Keynesian monetary and fiscal policy, adherence to multiplier theory causes more damage by the Keynesians than by the Monetarists or Austrians.

This is because, while all of them operate within the flawed Currency Principle paradigm, the Monetarists and Austrians tend to view the multiplier effect as descriptive, while Keynesians view it as prescriptive. Thus, where the Monetarists and Austrians can afford to be wrong because, in general, both schools say the government should leave the private sector alone, the Keynesians say the government can fiddle with monetary and fiscal policy in order to bring about desired results . . . assuming, of course, that the multipliers function as described.

Unfortunately, none of the multipliers, based as they are on a false assumption, function as described. Consequently, economists in the three mainstream schools twist themselves into knots (and get Ph.D.s and tenure) trying to figure out why bad assumptions result in bad prescriptions and disastrous policy decisions.

That being the case, here's our take on the various multipliers.

The Money Multiplier. As we noted above, this applies to the alleged way in which money is created under fractional reserve banking. It assumes as a given that checks are drawn, accepted, and deposited, but never presented for collection. A full refutation of the money multiplier is found in Harold G. Moulton's The Formation of Capital in the chapter on how banks really create money. The sole justification for the money multiplier is to try and discredit Say's Law of Markets and the real bills doctrine by setting up a straw man.

Fiscal Multipliers. There are a number of these, all purporting to describe how government fiscal policy affects the economy. All of the various fiscal multipliers assume as a given that the massive amount of private sector money in the economy represented by all the different types of bills of exchange is not really money. Accordingly, the actual functioning of any of the multipliers must be treated as a "black box." Results are negated by the fact that private sector money affects the economy even more than government fiscal policy. It is therefore only by chance that a fiscal multiplier describes reality. All fiscal multipliers are consequently useless as analytical tools. Using a fiscal multiplier — it doesn't matter which one — as the justification for government fiscal policy is a recipe for disaster, or (at least) some really stupid decisions.

"The" Keynesian Multiplier. The Keynesian multiplier is a fiscal multiplier that purports to describe how government spending affects the economy. As such, the Keynesian multiplier is no better than any other fiscal multiplier — or the money multiplier, for that matter — in describing reality. In fact (and we sweartogod that we started writing today's posting before we saw today's Wall Street Journal), according to Dr. T. Norman Van Cott, Professor of Economics at Ball State's Miller College of Business (that's in Indiana, for those of you not familiar with the geography of the civilized states), the spending ("Keynesian") multiplier is voodoo. (Page A16, if you want to check.) We've no idea what Dr. Van Cott thinks about binary economics, but it appears that he might have a leg up on Moulton — which is halfway there. Maybe he should be talking to Norman Kurland or Bob Ashford at Syracuse Law School.

Now you know everything you need to know about "the multiplier" . . . which is pretty much nothing, since multipliers really don't do anything except justify what some politician has already decided to do.



Lee Shin said...

spot on with this write-up, i like the way you discuss the things. i'm impressed, i must say. i'll probably be back again to read more. thanks for sharing this with us.

Lee Shin

Michael D. Greaney said...

Thanks. I have to admit that when I took economics in college at the same time I was majoring in accounting, the money multiplier always bothered me, but I couldn't say why. After I audited in the "real world," I figured out why: the Keynesian money multiplier relies on a type of accounting fraud called "kiting," i.e., moving payments from one customer account to another, all the while recording the payment in both.