Bad Policy – Multiplied

by Mike Lowry

In this critique of George Bush’s economic stimulus plan, economist Frank Shostak sets out to debunk the myths of the Keynesian philosophy. Specifically, he levels a common-sense attack at the concept of the “spending multiplier” which the success of the stimulus package is predicated on.

Recall that the spending multiplier is the change in Y that results from a change in autonomous spending. The degree to which Y changes is dictated by the MPE, the slope of the planned expenditure line. The goal of the Bush stimulus plan is to increase consumer spending by increasing the disposable income of low- and middle-income consumers. Under the assumption that these individuals have a high propensity to consume, the logic is that the increase in consumption will result in a cascading series of transactions between firms and households that will stimulate production thereby increasing Y.

According to Shostak’s characterization, the multiplier model indicates that increasing savings is bad for the economy and that the Keynesian philosophy says that only demand for consumer goods drives economic growth. Shostak takes exception to both of these points. He argues that the reasoning behind the multiplier effect demands that something be derived from nothing. The cascading series of transactions does not result in the creation of new wealth; it only redistributes the amount of real savings that is already tied up in consumer goods. Furthermore, rather than production being driven by demand, production can only truly increase by investing in capital. Therefore, the stimulus package, which is intended to increase the demand for consumer goods, will be fruitless unless the increase in disposable income is reinvested in capital.

Shostak’s argument against the multiplier makes as much sense to me as the level of emphasis our textbook places on the multiplier’s importance. That is to say I’m as easily swayed one way as the other. To me, determining whether or not the stimulus package is a good idea is much more simple. Decreasing taxes at a time of heightened government expenditure really just means that Bush intends to send us Chinese yen cleverly disguised as U.S. dollars.

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