The multiplier effect is one of the chief components of Keynesian countercyclical fiscal policy. According to Keynes's theory of fiscal stimulus, an injection of government spending eventually leads to added business activity and even more spending. This theory proposes that spending boosts aggregate output and generates more income. If workers are willing to spend their extra income, the resulting growth in the gross domestic product GDP could be even greater than the initial stimulus amount. The magnitude of the Keynesian multiplier is directly related to the marginal propensity to consume.
Its concept is simple. Spending from one consumer becomes income for another worker. That worker's income can then be spent and the cycle continues. Keynes and his followers believed individuals should save less and spend more, raising their marginal propensity to consume to effect full employment and economic growth. In this way, one dollar spent in fiscal stimulus eventually creates more than one dollar in growth.
This appeared to be a coup for government economists, who could provide justification for politically popular spending projects on a national scale. This theory was the dominant paradigm in academic economics for decades.
Eventually, other economists, such as Milton Friedman and Murray Rothbard , showed that the Keynesian model misrepresented the relationship between savings, investment, and economic growth. Many economists still rely on multiplier-generated models, although most acknowledge that fiscal stimulus is far less effective than the original multiplier model suggests. The fiscal multiplier commonly associated with the Keynesian theory is one of two broad multipliers in macroeconomics.
The other multiplier is known as the money multiplier.
- Please Consider Donating;
- Perro guardián (Spanish Edition)?
- The Keynesian perspective on market forces (article) | Khan Academy?
This multiplier refers to the money-creation process that results from a system of fractional reserve banking. The money multiplier is less controversial than its Keynesian fiscal counterpart. Keynesian economics focuses on demand-side solutions to recessionary periods. The intervention of government in economic processes is an important part of the Keynesian arsenal for battling unemployment, underemployment, and low economic demand. The emphasis on direct government intervention in the economy places Keynesian theorists at odds with those who argue for limited government involvement in the markets.
Lowering interest rates is one way governments can meaningfully intervene in economic systems, thereby generating active economic demand. Keynesian theorists argue that economies do not stabilize themselves very quickly and require active intervention that boosts short-term demand in the economy. Wages and employment, they argue, are slower to respond to the needs of the market and require governmental intervention to stay on track. Prices also do not react quickly, and only gradually change when monetary policy interventions are made.
This slow change in prices, then, makes it possible to use money supply as a tool and change interest rates to encourage borrowing and lending. Short-term demand increases initiated by interest rate cuts reinvigorate the economic system and restore employment and demand for services. The new economic activity then feeds continued growth and employment. Without intervention, Keynesian theorists believe, this cycle is disrupted and market growth becomes more unstable and prone to excessive fluctuation. Keeping interest rates low is an attempt to stimulate the economic cycle by encouraging businesses and individuals to borrow more money.
When borrowing is encouraged, businesses and individuals often increase their spending. This new spending stimulates the economy. Lowering interest rates, however, does not always lead directly to economic improvement. Keynesian economists focus on lower interest rates as a solution to economic woes, but they generally try to avoid the zero-bound problem. As interest rates approach zero, stimulating the economy by lowering interest rates becomes less effective because it reduces the incentive to invest rather than simply hold money in cash or close substitutes like short term Treasuries.
The features of this era can be seen as some kind of blueprint for the kind of economic system post-Keynesians advocate for. In order to get there, the overarching political objective is to change the effectiveness of the state and the political-economic system. The question of how this can be achieved in the social and political domain is not often directly answered in PK literature. While there are some attempts in PKE which investigate the question of the socio-economic and socio-political factors that can lead to certain shifts of overall economic or capitalist regimes, it can be argued that these questions are not the major concern of PK academic literature.
These include stagnation, excessive inflation or deflation, recessions, financial and economic crises, among others. For example, many post-Keynesians argue that a more even distribution of income between capitalists and workers will boost aggregate demand and growth and can therefore result in increasing the gross profits of the capitalist class. This emphasises the fact that for PKE, there is no fundamental trade-off between social cohesion as a political target and growth as the economic means to maintain high levels of employment and to improve living conditions.
However, as the analysis of social developments leading to political change are of minor concern relative to specific economic policy recommendations in PKE, one can easily get the impression that the PK approach to politics has a certain affinity to technocracy. Most post-Keynesian economists would subscribe to the idea of achieving a more socially just system, with full employment, low levels of income inequality and high levels of individual freedom. While today many post-Keynesian economists do recognise that infinite growth is problematic from an environmental perspective, it remains the central instrument to achieve full employment and therefore can be seen as a key goal of PKE.
PKE favours a macroeconomic policy mix with an active role for fiscal policy to stabilise the economy in the short and the long run. Monetary policy should target low interest rates to provide stability in the monetary, financial and real sector. Other policies to stabilise the economy could be achieved with strict financial market regulation via credit controls, asset-based reserve requirements, among others. Also, it is considered important that central banks act as lenders of last resort.
Wage and incomes policies should lead to steady nominal unit labour cost growth in line with the desired inflation rate. PK economists are generally supportive of trade unions as they have an important influence on wage bargaining coordination and therefore price stability. Regarding international economic policies , PKE does not regard free trade as beneficial for poorer countries as long as it does not help them to build their own competitive manufacturing sectors. To achieve that post-Keynesians favour capital controls, managed exchange rates and infant industry protection.
There are different areas of debates and analyses that PK research has concentrated on. The focus that is placed on different problems and research areas is strongly influenced by the developments of economies and societies, by fads and fashions, by the advancement of computer technology and, of course, by historical events. One area where many contributions have recently been made is in the use of econometric studies trying to determine if a country is wage-led or profit-led.
While in wage-led countries an increase in the wage share leads to higher aggregate demand, it reduces aggregate demand in a profit-led country. In extensions to this approach, the effects of personal income inequality, financialisation, open economy issues, fiscal policy and other factors on growth are being researched. Furthermore, the notion of financialisation has recently given rise to a rich literature that describes and analyses structural changes in many economies towards a greater importance and dominance of the financial sector.
11.5 The Keynesian Perspective on Market Forces
The contributions in this field range from institutional and descriptive analyses on the micro- and meso-level to econometric studies and formal macroeconomic models. PK contributions to the financialisation debate highlight its negative effects on investment, income distribution and financial stability.
However, there are still puzzles to be solved such as how financialisation relates to neoliberalism. The overall awareness about ecological problems and, in particular, climate change have also had an influence on PKE.
However, it has to be said that traditionally, post-Keynesians did not spend a lot of time thinking about environmental issues but have focussed rather on achieving full employment by economic growth. However, the focus on environmental constraints has received a lot more attention in recent years. PK economists see ecological economics as having strong microeconomic foundations but relying too much on neoclassical macroeconomics, and so they attempt to introduce PK macroeconomics to the analysis. Finally, there has been a strong increase in the diversity of modelling methods used by PK economists.
For example, the GFC has generally reaffirmed the post-Keynesian insistence on the important role of money and finance for economic activity. This has given another boost to stock-flow consistent modelling. Large scale SFC models are being developed that describe an entire national economy, while multi-country open economy models look at international trade and finance.
Macroeconomic perspectives on demand and supply (article) | Khan Academy
Another field of advancement is agent-based modelling to understand how the complex interactions on the microeconomic level can affect macroeconomic outcomes. This is still in early stages as post-Keynesians have only recently started to work with these models. Other authors focus on issues like disequilibria, instability, and how the economy moves from one equilibrium to another through time.
This research area employs increasingly complex models with non-linear dynamics that often require computer techniques to numerically simulate different possible solutions to the model. These models give an insight into the sometimes chaotic adjustment processes that happen in the real world and thus have a very different flavour than the tranquil and harmonious mainstream general equilibrium models. The post-Keynesian school is comprised of several subschools, each with emphasis on different phenomena, while agreeing at the same time on important key notions. First, that monetary variables are essential to the understanding of the economy.
Second, effective demand drives the economy in the short as well as in the long-run. Third, the future is fundamentally uncertain , and so it is impossible to apply probabilities to different possible futures. Fourth, the economy is path-dependent which is why there is no predetermined equilibrium in the future to which the economy can adjust.
And finally fifth, they all regard distributional conflicts as very influential on the overall macroeconomic development in the short as well as in the long run. Relying too heavily on Keynes as the intellectual founding father also has its disadvantages as it can lead to sterile discussions about what Keynes truly said, or what Keynes truly, truly said.
Therefore, some economists claim that Kalecki - who published even before Keynes, but only in Polish at first - was in a way the true founder of PKE, as his analysis was less inspired by neoclassical theory. The name of post-Keynesian economics itself obscures the contributions of several different and influential authors. The so-called Fundamentalists base their theory mainly on Keynes himself and focus on the topics of the monetised production economy and financial fragility.
Perspectives on equilibrium
Their analysis made great contributions to the understanding of the Global Financial Crisis. Kaleckians are mainly interested with output and employment, business cycles, growth theory and pricing issues. The Sraffians focused more on relative prices and choices of techniques, among others. The Institutionalists encompass authors that look at the institutional setting of the economy. These include Minsky at least in parts , behavioural economists of post-Keynesian tradition as well as the Modern Money Theorists who focus very intensely on the institutional framework of government, banks and central banks.
Kaldorians mainly focus on long-run growth, and highlight the constraints that open economies have to face regarding growth and how economic structure matters for development. PKE has links to several other heterodox schools of thought, most importantly with Marxism and institutional economics, which also reject mainstream economics. The object of analysis of both Marxism and PKE is the capitalist economy where the relationship between employers and employees as well as the pursuit of profit are of fundamental importance.
For Marxists and PKE, money is a central element for the analysis of inherently unstable capitalist economies. Nevertheless, there are also important points of disagreement between the two paradigms. Importantly, most PK economists reject the Marxian labour theory of value or at least regard it as a rather useless concept. The Marxian idea of a tendency of the rate of profit to fall is another weakness. Both of these examples relate to differences in the methodological, ontological and epistemological views and beliefs in both schools.
The links between PKE and institutional economics are also very strong and maybe even stronger than the links to Marxism. PKE and institutional economics both emphasise the importance of social norms, conventions and habit formation to individual behaviour. In fact, PKE makes great use of the analysis of microeconomic and socio-political issues that can be found in institutional economics.
However, there are again some important differences between both schools, especially regarding methodology. For example, many institutional economists reject the formal and econometric modeling approaches that can be found in PKE. Summarising what has been mentioned above, PKE and mainstream economics differ regarding their epistemology and ontology, their understanding of rationality, their methods, and their economic and political core.
First, while PKE stresses the importance of realism - trying to tell relevant stories about the economy, based on real facts - mainstream economics follows the view of instrumentalism - which does not care about the degree of reality reflected in their assumptions, as long as they will allow precise predictions. Mainstream economists therefore use the concept of a perfect optimising agent. Also known as homo economicus, this concept allows them to make seemingly accurate predictions about the future economy, while not taking into account that humans do not behave like this agent in reality.
In contrast, PKE uses the concept of satisficing agents. Like real humans, these follow rules of thumb and make decisions that suit an environment with fundamental uncertainty. The method of PKE follows holism , acknowledging that humans are social beings living in a complex system of institutions, gender, culture etc. In this view sensible behaviour by individuals on the micro level can lead to unintended consequences on the macro level see the paradoxes above for examples. Mainstream economics follows the idea of individualism where individual behaviour is simply aggregated to form a measure of macroeconomic level, ruling out any micro-macro paradoxes beforehand.
The economic core of mainstream economics is scarcity of resources, namely capital and labour. Therefore, mainstream economists focus on the allocation of these resources and hence view prices as an indicator of scarcity. In contrast, PKE considers empirical evidence and regards the economy to be generally running below full capacity. This shapes their view of the economy being in abundance. Their main concern is rather how to employ all the idle labour and capital. They understand prices as indicators of the unit production costs.
Finally, the political core of mainstream economics is based on the belief that unregulated markets lead to an optimal allocation of scarce resources.
PKE, although acknowledging the positive entrepreneurial effects, is highly suspicious of unfettered markets and tend way more toward tight regulation. Year of publication: Edward Elgar Publishing. Year of publication: Oxford University Press. It is committed to diversity and independence and is dependent on donations from people like you. Regular or one-off donations would be greatly appreciated. Home Orientation Post-Keynesian Economics. Post-Keynesian Economics. Eckhard Hein 1. Thus the theory cannot possibly explain how a healthy market economy functions—how the market process allows one kind of activity to be traded off against the other.
Any increase in spending, then, whether originating from the private or public sector, gets multiplied through successive rounds of income earning and consumption spending. The accelerator mechanism is a consequence of the durability of capital goods, such as plant and equipment. For instance, a stock of ten machines, each of which lasts ten years, can be maintained by purchasing one new machine each year. A slight but permanent increase in consumer demand for the output of the machines of, say, 10 percent, will justify maintaining a capital stock of eleven machines.
The immediate result, then, will be an acceleration of current demand for new machines from one to two, an increase of percent. The multiplier-accelerator theory explains why consumption is increasing, given that investment is increasing, and why investment is increasing, given that consumption is increasing.
But it is incapable of explaining what determines the actual levels of consumption and investment except in terms of one another , why either should be increasing or decreasing, or how both can increase at the same time. Students are left with the general notion that the two magnitudes, investment and consumption, can feed on one another, in which case the economy is experiencing an economic expansion, or they can starve one another, in which case the economy is experiencing an economic contraction.
That is, Keynesian theory explains how the multiplier-accelerator mechanism makes a good situation better or a bad situation worse, but it never explains why the situation should be good or bad in the first place. Only at the two extremities in the level of economic activity is a change in direction of both consumption and investment sure to occur.
After a long contraction, unemployment is pervasive and capital depreciation reaches critical levels. As production essential for capital replacement stimulates further economic activity, the macroeconomy begins to spiral upward. After a long expansion, the economy is bulging at the seams. As unsold inventories trigger production cutbacks and worker layoffs, the macroeconomy begins to spiral downward.
Keynes held that the economy normally fluctuates well within these two extremes experiencing a general insufficiency—and an occasional supersufficiency—of aggregate demand. The market is envisioned, in effect, to be some sort of economic amplifier which converts relatively small changes in these external factors into wide swings of employment and output.
This is the basic Keynesian vision. Wage rates and prices are assumed either to be inflexible or to change in direct proportion to one another. The actual level of wages and prices is believed to be determined again by external factors—this time, trade unions and large corporations. If the real wage is too high, there will be unemployment on an economy-wide basis. There will be idle labor and idle resources of every kind.
The opportunity cost of putting these resources back to work is nothing but forgone idleness, which is no cost at all. The assumed normalcy of massive resource idleness assures that the perennial problem of scarcity never comes into play. William H. Hutt and F. Textbook Keynesianism has a certain internal consistency or mathematical integrity about it. Given the assumptions that prices and wages do not properly adjust to market conditions—that is, the assumption that the price system does not work—then the Keynesian relationships among the macroeconomic aggregates come into play.
Even the policy prescriptions seem to follow: If wages and prices do not adjust to the existing market conditions, then market conditions must be adjusted by the fiscal and monetary authorities to the externally determined prices and wages. In the final analysis, however, Keynesian theory is a set of mutually reinforcing but jointly unsupportable propositions about how certain macroeconomic aggregates are related to one another.