These days, it is commonly accepted that the motor of the economy is overall demand for goods. Hence the growth of an economy is dependent on the strength of this motor. That people still believe this shows that Keynesian economics is as popular now—on Wall Street and Treasury offices—as it was fifty years ago. An artificial boost in demand that is not supported by production leads to the dilution of the pool of real savings and, contrary to the Keynesian view, to a shrinking in the flow of real wealth. FULL ARTICLE
Source link: http://archive.mises.org/3978/the-myth-of-the-magical-multiplier/
The Myth of the Magical Multiplier
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Is this all true in regard to plain savings, or only in the formation of capital goods?
Though I agree with Shostak’s essay completely, I am willing to play the Devil’s Advocate.
Is it possible that the artificial demand of the government might induce the producers to direct a larger percentage of their remaining real savings towards capital goods rather than to final consumer goods? Could this ever be beneficial?
Could this ever be beneficial? Yes, but only by chance. Of course, it will be beneficial to who are initially impacted by the stimulation, but that’s no different than how outright theft initially benefits the robber.
In speaking of government spending and “investment” we must examine not only the fact that government takes away what it spends from producers, and therefore cannot increase the pool of real wealth, but we also must examine the disincentives to produce that arise from this activity. This is not merely a zero sum game, it is a negative sum game. The more the government confiscates the less incentive people will have to produce because they won’t be able to keep the fruits of their labor. This is especially true where the theft is progressive. It becomes almost completely unprofitable to produce beyond a certain level, so the most productive members of society will simply cease production once they reach a certain level of income. This has a shrinking effect on the pool of real wealth available for consumption and serves to limit an economy’s production level far below what it might be without the perverse disincentives.
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I agree with Aaron about the negative consequences of government spending. It does teach people to use of force — turning them from making to taking wealth.
Someone explain to me why an individual putting money into a mutual fund has a different economic effect from the Social Security Administration putting SS funds into a mutual fund?
billwald,
The economic effect considered in isolation might not be different, but the sheer size of the investment of Social Security would lead to government control of business to a greater degree than is the case today. Some on the Left would think that to be a good outcome, but I think very strongly that they are foolish.
For the record, I am not a supporter of Bush’s privitization plan- I thought it mostly a sham solution to the demographic crisis that is at the heart of such programs as SS and Medicare.
I found interesting the story Shostak quoted from Keynes. Now, having never actually read this story, I must accept that Keynes was serious? Keynes chose to ignore or did not even realize that it would cost as much in resources to bury the money as it would cost to dig it up? Somehow I doubt Keynes was serious when he wrote that. Does anyone more knowledgeable than I have any comments?
Yancey:
Wasn’t that Keynes’s quote a hoot? I laughed pretty hard at it.
I can’t tell you if Keynes was serious or not. However, i can tell you from a first hand experience that i had just 20 minutes ago that people who read stuff like that from Keynes take it very seriously and do not doubt it for a moment.
It’s just no fun quoting Keynes to Keynesians for a laugh because they don’t see what it is you think is so funny.
Try to explain it to them? Forget about it.
Bill:
The other difference between an individual putting money into a mutual fund and the Social Security Administration putting SS funds into a mutual fund is that the individual actually puts his money into a mutual fund.
In contrast, the SS gang spends the money on consumption and waste and lets the administration thirty years down the road worry about where all the stolen capital and interest is going to magically appear from.
The beauty of being a government official is that you can steal from people’s retirement fund and not go to jail. Most people won’t even realize what hit them. What a great life it must be.
I had to respond to this one too:
Yancey: “Is it possible that the artificial demand of the government might induce the producers to direct a larger percentage of their remaining real savings towards capital goods rather than to final consumer goods? Could this ever be beneficial?”
Could this ever be beneficial? There are two answers:
1. Always: Government spending always benefits someone no matter what. Even if it is just a politician and maybe a few of his favoured associates.
2. Never: Someone already had his property confiscated unethically for this demand to be created. Economics knows for certain that someone was harmed by the theft. Economics cannot assume that the benefits obtained by it ever made up for that.
Secondly, again never, because if the market indicated that those resources should have gone to consumer goods rather than capital goods then that is what maximizes utility. If people want to consume more than invest, letting them do so to maximize their preferences maximizes economic utility. It is the government intervention, discouraging savings and investments that is harmful, not free market consumption.
From what reading I’ve done on Keynes I believe
he was not being serious, this was his way of ridiculing the gold mining industry. Sorry, I forget the source here, it might have been Hazlitt.
Hi Yancey,
Was Keynes serious? I think one can never tell. Why? I quote from Rothbard’s “Keynes the Man”:
“Maynard Keynes’s approach in economics was not unlike his attitude in philosophy
and life in general. “I am afraid of ‘principle,’” he told a Parliamentary
committee in 1930 (Moggridge 1969: 90). Principles would only restrict his
ability to seize the opportunity of the moment and would hamper his will to
power. Hence, he was eager to desert his earlier beliefs and change his mind on a
dime, depending on the situation.”
-From the section “The Economist: Arrogance & Pseudooriginality”.
I’d agree with Rothbard that Keynes was more an egoistical, immoral Apostle than a serious economist with genuine good intentions for the lot of the common man. Keynesians will beg to differ, of course
Those of you who are interested in Keynes thought should read this article by Joe Salerno “The Development of Keynes’s Economics: From Marshall to Millennialism”. In goes deep into his philosophical idea’s. I can tell you that guy was a real piece of work. That he could ever have such a impact with the General Theory is just unbelievable, but then again that’s what you get when you tell governments exactly what they want to hear.
Having just finished Addison Wiggin’s “The Demise of the Dollar” ((http://www.amazon.com/exec/obidos/tg/detail/-/0471746010/qid=1124380696/sr=1-1/ref=sr_1_1/102-5512865-1865732?v=glance&s=books), there is clearly no magical multiplier but, on the contrary, only a diabolical one:
“The official position concerning economic expansion ignores the reality. Fed Chairman Alan Creenspan repeatedly points to high levels of consumption spending as evidence of a strong economy. This ignores the basic economic principle that makes a distinction between production and consumptive debt. … Economists [worthy of the name] recognize that productive debt leads to permanent and long-term economic growth. In contrast, consumptive debt — which is the modern basis for the economic ‘recovery’ pointed to often by the Fed and the Bush administration — is spending to purchase material goods.”
To ‘recover’ in this way now requires that the U.S. borrow some $2 billion a day from foreigners, the multiplier effect of which cannot but be disastrous. As Wiggin continues, “We don’t know when the exact moment of truth will arrive, but we know it will not be far off.”
Thanks to both authors for explaining why, and thanks to Wiggin for explaining how we can not only survive the Day of Reckoning but prosper from it. (And as for those who find this callous, my response is: Someone’s got to sew the seeds of real recovery, the more who do, the better. So why not be one of them?)
I am going to make some rather profane comments and welcome responses to these observations. Frank Shostak in his series of essays here has highlighted the Mises philosophy of money and economics as opposed to Keynesian ideas that are considered conventional wisdom. He talks about the multiplier effect as not possible according to Miserian principles but never the less it seems to be working. How can one deny something that is actually there in front of you? Now I know the argument is that it can not last and that eventually it will collapse on itself but never the less it does exist at the present time. It would be like saying that you as an individual can not exist because at some point you are going to die since no one lives for ever and there for you are wrong to exist!!
In a perfect world situation the Miserian ideas would be the way to do things but this has never been a perfect world nor will it ever be. My studying of Human history from the beginning of human civilization has shown one group of individuals dominating and taking advantage of another group(slavery including economic slavery).Despite our knowledge of science and advances in technology our character has not changed. We have not evolved as a species into a more nobler homo sapien.
My point is that we continuously go through cycles of progress and collapse in various cultures and this will not change over time. Every culture since the beginning has eventually collapsed over time and was replaced by another stronger culture that was more adaptive to the changing environment.
Tyranny in one form or another is man’s nature and will not change any time soon. At some point people like Bob Prechter who views a coming world wide depression may become recognized for their beliefs and the Miserians may get their 10 minutes of fame (ala Andy Worhall). In the end when the new world order establishes itself again it will be the same system as before but perhaps with a different name and different players. The rules of the game will be the same.
One reason that I hold this view is that despite the overwhelming evidence of how a miserable failer communisum has been it is still quite a popular held view among many people even in this country. When I asked my niece how she could still believe in those ideas she said the communists failed because they had the wrong leaders. With the right leadership communisum could work quite well. We can only repeat the mistakes of our ancestors despite our large body of recorded human history.
My point here is not that the Miserians are wrong in their beliefs of fairness to everyone
but that these concepts are counter to man’s nature and on a longer term basis will never be established on an ongoing basis; if ever. The stronger and smarter groups of people that have the ability to control all others would never allow these principles to establish themsevles since it would take away their power to control everyone else.
I know this is a very pessimistic comment but I do not know what else to believe at this time and welcome other’s comments on these remarks.
I also am sorry for any spelling errors, etc since there is no spell checker. Best to all for I certainly have learned alot by reading the essays and comments from this web site.
I do not believe that it is correct to associate the financial forecasting views of Robert Prechter with the economic theories of Mises or for that matter any other Austrian economist. Financial and economic forecasting require entrepreneurial judgment, and this skill can not be taught by theoretical economics or for that matter by any other formal discipline. Furthermore, I’m not sure to what extent Mr. Prechter embraces Austrian economics; referencing one or two aspects of a school of thought that fit into one’s story does not, in my opinion, constitute adoption.
Also, and this issue concerns methodology/epistemology, one should not utilize historical data to support economic theory. In fact, the Misesian/Rothbardian position is that it is economic theory that enables one to understand and interpret historical events. The data of history can not be properly interpreted outside of a conceptual economic framework. Even more generally, the laws of human action and of economics are operative regardless of the historical specifics, including the existing legal and ethical frameworks. Theories of history can not have the apodictic character of a correctly reasoned economic theory.
Dr Shostak presents his debunking of Keynes in a lucid, easily readable and easily understandable form. Perhaps in the future he may consider writing a book that introduces novices to the fundamental concepts of free-market economics. Such a book is sorely needed. It may be an excellent companion book to Henry Hazlitt’s ECONOMICS IN ONE LESSON.
Political leaders get away with imposing their Marxist and Kenynesian ideologies on to the population and causing economic ruin because the bulk of the population knows absolutely nothing about the fundamentals of economics. They depend on the Keynesian and Marxist charlatans who have taught economic mythology as fact to successive generations of students who have attended state-funded colleges and universities.
Harry Valentine
Dennis Stuart,
With all due respect, I can’t tell you how tired I am of hearing about how depraved mankind is and that libertarianism/Austrianism requires “a perfect world” and is therefore an impossible.
In the first place, if mankind were as depraved as you say, then chaos would reign, for not even the heavy hand of the state could maintain order, at least not for long. In reality, however, the state simply feeds off the spontaneous order that society creates as it literally goes about its business, the inherent inability of the state to control its appetite being what, time and again, brings about collapse. Even though society bears the brunt of it, however, it is the state that collapses, and with the coming collapse of the democratic state — which Francis Fukuyama famously hailed as “the final form of human government” — humanity will at long last be able to ask, in all seriousness, whether the problem isn’t what kind of state should exist, but whether the state per se should exist.
The true libertarian (as opposed to the “regime libertarian” that Lew Rockwell has recently, and rightly, condemned) answers, emphatically and unequivocally, that the state should NOT exist and that if left to its own devices, society would get along just fine, secure in the knowledge that the best way to improves one’s lot in life is to assist others in doing the same, that Adam Smith’s “invisible hand” might work its common sense magic. And I for one am optimistic that, following some unavoidable pain, the collapse of the American welfare-warfare state, wherein power devolves back to the individual states, will create the conditions for a libertarian awakening in the form of any number of experiments in free (i.e., stateless) society.
So stick around, Dennis, as a cure for your pessimism may well be at hand.
Good Article, I never realized Keynes could get even more absurd from what i knew about him. Whats even worse than burying money is his “priming the pump” arguement. “Since i know my theory is pretty stupid, i’ll just argue that the money jars go str8 to useless interests and have the government spend it”. He acts like people in poverty (which “justifies” over 1/2 of keynesianism) will ever stop spending free money. Many poor only consume and seldom produce. WHy would they change their habits and “save” more if new money keeps coming in, especially with inflation? I dunno, it seems like every new page of keynes has to make up an excuse for the fallacies of the previous page.
In his book “Peddling Prosperity”, Paul Krugman picks up Keynes’ cash bottles argument:
The first, and most obvious, thing to do is to make it possible for people to satisfy their demand for more cash without cutting their spending, preventing the downward spiral of shrinking spending and shrinking income. The way to do this is simply to print more money, and somehow to get it into circulation. Keynes whimsically suggested hiding bottles full of cash where enterprising boys might find them; Milton Friedman was later to offer the image of currency dropped randomly from helicopters. Fortunately for the dignity of monetary policy, there is a more respectable method: in a so-called open-market operation, the Federal Reserve buys U.S. government debt, paying for it with newly created money, which is thereby injected into the economy and put into circulation. (p. 31)
Krugman also offers the example of the “baby sitting co-op recession”. A group of young professional couples with children forms a baby sitting co-op to look after each other’s children. They issue coupons each one worth 1 hour of baby sitting. However, after some time the co-op gets into trouble. Krugman writes
For some reason the number of coupons in
circulation per couple became rather low. This
had peculiar counsequences. Since on average
members of the co-op had fewer coupons in hand
than the reserve they wanted, couples tried to
increase their reserve by baby-sitting more
and going out less. But one couple’s decision
to go out is another’s opportunity to baby-sit
[...]. The result was a sharp fall in the
volume of baby-sitting actually taking place:
couples sat glumly at home, unwilling to take
a night out until they had accumulated more
coupons and nobody else was going out either.
In other words, the baby-sitting co-op had
managed to get itself into a recession.
Finally an economist comes along and hey presto here comes the solution: increase the number of coupons in circulation. All of a sudden people start going out more and everybody’s happy.
Does anyone else see a problem with this argument or is it just me?
Harry Valentine,
Reasons that I believe are important in explaining why Keynesianism and Marxism are so widely accepted is that they both feed on the personality traits of jealousy and envy, which unfortunately animate all too many human beings. In addition, both Keynesianism and Marxism feed on most individuals’ desire to get something for nothing, take the easy way out, and have someone else pay for things that they believe they have a right to possess.
OT:
great book = The War on Gold by A Sutton
he references ‘the theory of money & credit’ and ‘human action’.
Dennis Stuart,
You should read The Sovereign Individual by James Dale Davidson and Lord William Reese Mogg. It may change your views on what is or is not possible with regards to change and progress.
I think that in deep recession alternative cost ( in terms of opportunities found elsewhere ) of resources used by government can be quite low, since workforce is sacked and many plants are closed. Then it might be actually beneficial to “boost” demand by using those idle resources and this way promote employment. But only when employment is below full-employment level.
But usually this has led to permanent increase in general government expenditures and resources have been diverted to uses where they might not be optimally allocated. And it also might be true that long term consequences of government interference might harm economy more than short term benefits of active counter-cyclical policy.
Dennis Stuart,
Reading your comments gave me the distinct impression that you believe Austrian economics (the school of thought of Mises) is in some way new or untested — utopian even. Untrue! The Austrian school of economic thought has roots going back to the beginnings of economic theory. It is Lord Keynes who is the relative newcomer. And, many of Keynes most ardent followers were fans of Austrian economics until Keynes came along.
Hello,
I must first mention that I am an Electrical Engineer by trade, not an economist. Only recently (a few months ago) did I discover the Mises website which gave me a great interest in learning more about economics.
Anyway, the essay gave me an insight as to one possible reason, other than one’s economic philosophy, why there is divergent opinions as to the macroscopic economic effect of savings: Ambiguity in the term “savings” itself in respect to the “storage time” involved.
The essay (seemingly immediately) has Bob the farmer “spending” his “savings” of tomatoes, thus keeping things flowing, in the economic sense. I personally associate the term “savings” with “storage” for some arbitrarily medium to long term. Perhaps Bob the farmer bottles or cans these extra tomatoes and sets them on a shelf for a couple years AND THEN takes them to market — this is my (naive?) idea of what savings is.
I can see how those who define savings in the latter sense can be worried that this economic (in)activity is a “bad” thing for the rest of the economy (at least to some bean counter attempting to calculate statistics on the “health” of the economy).
But isn’t the saver performing the saving (in any duration, long or short) for his/her own benefit? And doesn’t the continued happy/healthy existence of the saver (farmer Bob) ultimately equate to more product from which the larger economy benefits? That is to say, how can those trying to calculate the macroscopic effects of saving try to “second guess” the saver?
If farmer Bob “saves” in the “storage” sense, it may lower the statistics that the bean counters (government?) keeps and make them unhappy, but it also may be because farmer Bob needs the extra tomatoes to stay alive until next season — which may turn out to be a record crop and thus actually turn out better for the entire economy – but at a later date. If farmer Bob acts to keep government happy NOW he may not exist LATER to make things better overall.
Hi Ray:
Welcome to mises.org. I think you’re going to find many of us are not professional economists. For instance, I’m an EE like you. By the sounds of it I think we’re at an advantage because the only economic theory we have substantially been exposed to is Austrian. And that means we avoided some wasted time learning Keynesian convolutions. I think your observation about the confusion around the definition of savings is astute. Just when i think i have it nailed, i realize that i might need to re-think it a little further. I did find the Misesian break-down as the following useful: What do we do with our gold (if gold was money):
1. Hold/Hoard it: keep cash in our wallets, vaults and under our mattresses.
2. Consume it: spend it on consumption goods for living day to day.
3. Save/Invest it: spend it (or lend it to be spent) on capital goods, land and labour to create a good that is one step closer to a consumer good.
So from that perspective saving is investment because it is spent in the effort of production and recouped later in time with interest.
On the other hand, the cash in your wallet and in your vault is not savings, but cash holdings: it is what constitutes the demand for money.
Consumption spending i think is the simplest: it’s what we do when we spend money on ourselves to live and for pleasure.
And finally, i agree with you that there is no point in second guessing the individual’s decision on the amount of his holding of money (hoarding). He is doing what is right for him, which is sufficient to conclude he is doing what is optimal, since he is not aggressing against anyone in doing so.
My recent post commented on savings, but the main topic was really about something called the “Magical Multiplier”.
Re-reading the essay gave me the feeling that economists who subscribe to the magical multiplier myth believe in an ecomonic version of “perpetual motion”, or “over-unity” output from a system.
The example given (of $100 to $90 to $81…) also reminds me of the action of a slot machine that has a 90% payback average. Lets say I take a notepad with me to the casino and record my wins as part of my personal “GDP”.
I “invest” my initial $100 and afterward count my “return”, $90, and write this amount in
my notepad. Likewise, I “re-invest” the $90, which gives an $81 “return”. Using the magic muliplier, my personal GDP is now $100 + $90 + $81 = $271! Wow! But would any (sane) ecomonist say I should keep playing as it is highly probable that I can further increase the multiplier of my personal “GDP”?
Of course not, a sane economist would say that there is still really only $100, of which I have $81 and the casino has $29 by this economic activity.
Correction to my last post: The casino has $19, not $29. Using my math, there is a possiblity of perpetual motion
Hi ….. Does Gov’t spending have a greater effect on the economy than private sector spending? What would happen to the US economy if welfare (food & housing handouts) were reduced? … Thank you. …. Bert J Ryder
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The Myth of the Magical Multiplier……
i have seen that term mentioned here at these sites. is it a myth or a deliberate lie????
when you multiply money do you just make more (as opposed to earn) of it???
On the other hand, the cash in your wallet and in your vault is not savings,……..
i dont know if thats true or not. if you stash money away for a later time that is saving money.
So from that perspective saving is investment ………….then why call it saving if its investment.
The multiplier effect will just cause higher velocity of money (which is what this argues), higher velocity of money will mean higher prices (more demand), but according to keynesian theory it will also mean higher production AFAIK. However, can it mean higher production, because for higher production you need more input and savings, and if prices rise employers want also more wages? On the other hand, is the production justified, because afterall it is artificial – people don’t really want the stuff absent of the economic policy. Of course the stickiness of wages has to be considered too, but IMHO there are better ways to deal with that.
Anyway, the multiplier effect is kind of stupid, because money by default circulates, so there is a multiplier effect in the first place, this multiplier is removed when government taxes the money. When the money is spent it is artificial demand, for stuff that is not wanted. That is not good. Meanwhile savings are reduced – meaning less investment that is needed to dig your way out of shocks and reform the economy to be viable.
From this analysis it would seem like the stimulus of aggregate demand leads just to retarded growth. There is no fairy.
That is at least my analysis of it, I may be wrong though. Overall I think these keynesian policies are trying to create something out of nothing. Maybe some day some better mathematicians look at these things and prove that conclusion…
GDP will of course raise from this kind of stuff, as the price incrementation lags behind.
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