Demand Side, the Book

Chapter 14:

Demand Side Tools, Forecasts

The Multiplier

bold is in chapter 2

In concert with its originator R.F. Kahn, Keynes also developed and promoted the multiplier. Investment or government expenditure creates an economic surge as it echoes through the economy. The producer of one good is the consumer of another as his good is sold and he spends his income. Thus, money can be followed from hand to hand as it facilitates the exchange of goods and services. The same money buys shoes from the shoemaker as buys bread from the baker as buys meat from the butcher, but the consumer changes from shoemaker to baker to butcher. If the money stops - as above - in one or another's cookie jar, the sequence of purchases and sales is interrupted and the employment of people and facilities down the line never occurs. The economic activity is stopped by the act of hoarding.




The corollary to this sequence is Kahn's multiplier. Any particular amount of government spending or private investment will create multiples of that amount in economic activity, as the first new income is passed from consumer to producer, who then becomes the next consumer. The multiplier describes how much more activity will be created. It is the multiple of investment or government deficit spending in real increased economic activity.




Different economic actors will affect the multiplier differently. As the money passes through a poor person, for example, it will likely survive intact as a purchase of a good or service because a poor person tends to spend all of his or her income. Similarly, payments that go through government accounts tend to employ people and survive as demand for the subsequent services, because government is not in the business of saving. In contrast, payments to the wealthy are not so readily turned over. The tendency to save or spend in a manner which is tangential to the main economic life of the society is much greater among the wealthy. A full exploration of the multiplier and the factors that act to reduce it is presented in a later chapter.


Today the multiplier survives primarily to describe the stimulus value of government deficits and to offer an inappropriate justification for all tax cuts. Keynes himself preferred direct employment through public works.

 As all reliable economics texts will attest, direct government spending is undoubtedly greater stimulus than tax cuts, since the first round of leakage from private spending is absent in government spending. Tax cuts balanced by spending reductions are undoubtedly contractionary, for the same reason. Tax cuts funded by deficits is absurd economically, as it means revenue formerly generated in taxes is now being borrowed. Yet this is precisely the policy of the current Bush administration. The same revenue thus comes with the cost of interest attached.


Tax cuts also produce on the margin of personal demand. The "margin" refers to the last increment. Marginal income tax rates, for example, refer to income above a certain level. Income below that level is taxed at a lower rate. In the case of tax cuts, the money freed up to individuals and households would be spent on items less essential than the first dollars of income. Thus tax cuts produce more discretionary goods and services than direct employment from public works - more deodorant and cell phones and fewer houses. Public works employ people directly and distribute demand across the full spectrum of household needs.

The liquidity trap

Examples of those public goods:

Rail.  Because our current private goods automobile-centered transportation consumes so much space and so many resources and produces planet-strangling pollutants and greenhouse gases, it is a good demonstration of the private goods to public goods move we need.  In rail we have the opportunity to replace imported oil with domestic infrastructure, reduce pollution, free physical space for other uses, and create a stable jobs-producing industry.  Unfortunately, the public good of rail is captive to the rail industry which cannot capture all its benefits and so seeks to maximize its return on capital and minimize its investment by concentrating on modular, long-haul and bulk freight, rather than passengers or short-haul freight that would reduce or replace freeway expansion.

New non-polluting fuels.  Methanol, fuel cells, and other advances into a clean energy future can be developed by private corporations for profit if the government will only guarantee a market for the product.  This is called "advance commitment procurement" and involves no public expenditure on the development of products, only the commitment to buy such a thing if it is developed.  At a specific, not open-ended price.  Or, as California has done with its pollution restrictions, the market can be described and those who want to participate in it have to meet the guidelines.  The catalytic converter and tens of billions of dollars in private R&D have been generated without a dime of public money by these kinds of guarantees.

Clean Energy and Conservation.  The green energy sources are essential, and developing the technology for clean energy can give Americans the growth industry of the next century. This is more well described by others.  At the same time, simple conservation and building retrofitting is a no-brainer in terms of financial payback.  The government need only provide a financing mechanism that can capture the savings and private contractors will do the work.  Such activity, of course, provides a big new market for conservation in housing, urban design, and building products.  Again, the markets can be produced by both incentives and disincentives.