The Multiplier Effect; The Phillips' Curve; Spending vs. Saving during Recessions?

Economics Economics Questions
1

I just got a comment on this blog of mine, titled: “Why the “Stimulus” Will Only Make the Recession Worse, & Why Government Should Not Attempt to Prevent Bankruptcy.”

The text of the comment (which is not visible from the blog) is as follows:

  1. Spending does create wealth, this is what Keynes defined as the ‘multiplier effect’ on the economy. The basic formula is 1/(1-MPC), in which the amount of government stimulus needed is G= Change in RGDP/(1/(1-MPC)). Spending money sends a shockwave throughout the economy. The amount spend by the governemnt becomes income for someone, a portion is saved while a portion is spend. This additional spending becomes income for someone else…and the cycle repeats. When an economy is in a recessionary gap, consumer spending, investment spending, and net exports drop significantly. Ultimately, deficit spending by the government on infrastructure is what is needed to pull us out of the recession. Also, there is a crowding in effect of firms because the government is seeking to buy certain goods/services.

  2. The government always (in the short run) has to choose between either less inflation and less jobs or more inflation and more jobs. This is the nature of the ‘Phillip’s Curve’ in economics. When the government monetizes the deficit, it not only buys its own bonds but seeks outside sources to buy its bonds and thus retains the value of our fiat currency. It’s uncertain that you will see a significant drop in real income or real wealth as the economy gradually begins to recover. Refer to the ‘AS and AD’ graph, if government demands more money and spends it the net effect is both the AS and AD curves shift to the right. While you see an increase in the PL, you also see an increase in RGDP. Monetizing excessively is not a good thing, but it is great for the short term.

  3. Having the population save their income during a recession is NOT GOOD! You WANT to give incentive for consumer spending. If the consumer see’s that his income/wealth increased, even though it may not have increased in real terms, he/she will still spend and thus contribute toward the shift in the AD curve. Your bread analogy is a terrible and completely fallacious analogy. If you buy and eat bread (ignoring the already existing multiplier effect), your going to get hungry again and need to buy more. This will occur with an array of consumers, who will want to buy more bread and therefore increase the demand of bread. The end result is, with greater demand for bread via consumer spending, there is a greater demand for labour (aka jobs) to produce and sell bread.

So how much of this criticism is valid? Does anyone have any rebuttals to them?

If not, what part of my blog was incorrect?

Thanks in advance for any input.

2

Sorry,that first paragraph should have read:

"I just got a comment on this [http://freedomsring.wordpress.com/2009/05/03/stimulus] blog of mine, titled: “Why the “Stimulus” Will Only Make the Recession Worse, & Why Government Should Not Attempt to Prevent Bankruptcy.”

3

First off, I doubt that this person will have any conception of the ABCT (the recession came about as a result of an inflationary boom, there are not enough savings to see investments finished, misallocation of capital has occured, etc). Rather, the commenter will see this as a “collapse in demand”, and that spending, no matter who the spender is, is required to “raise AD”. All of his arguments neglect the capital structure of the economy.

Secondly, you could use historical examples to why every single one of his arguments is historically bankrupt. For instance the depressions where the government “spent a lot of money on stuff” lasted the longest. The ones where the government did nothing lasted a short time. The 1970s was a period of rising unemployment and rising inflation, indicating rising and falling demand. Theoretically impossible under the Keynesian doctrine.

The shortest answer to this claim is to say “so when Crusoe eats a berry then 3 more will magically appear?”*

Clearly, the ability to consume is derived from the ability to produce. Spending can’t create anything!

As Bob Murphy writes:

With all the talk of consumer spending and national income, we often forget that actual production must occur before people can consume anything. It doesn’t matter how many green pieces of paper are in your wallet; you can’t “demand” a TV set unless the store has an actual unit on the shelf. Pushing it back one step, no matter how many customers are lining up outside his store, the manager of Best Buy can’t stockpile his shelves with TVs unless the manufacturer has previously assembled them. And of course, the manufacturer can’t do so—regardless of how much money he is offered by the Best Buy manager—unless he can find enough workers, and enough of the relevant parts, to actually make the TVs.

We now see why the circular-flow diagram above is a very misleading model of the economy.

If you really want to see the theoretical aspect of the multiplier stripped bare through a reductio ad absurdum see pages 77-79 of this book.

Poppycock. Unemployment is caused by wages exceeding their market clearling levels.

Once again, you have to reinforce the fact that we are not in recession becuase of a sudden unwillingness to spend money.

4

Actually, unemployment is caused by a combination of these two:

  1. Workers prefering leisure to what a job can offer them in terms psychic satisfaction. If someone wants a job no matter what, they can pay for one.

  2. Government preventing a labor arrangement by force. (ex: minimum wage).

5

I think he was referring to involuntary unemployment.