Wednesday, January 11, 2017

Debunking the Multiplier Effect

I do not intend this to be a lengthy post because though the topic of economics and the multiplier effect may seem complex and nuanced, the truth is the entire economics "profession" has gone so far beyond it's philosophical roots, laughably treating itself as a "science," that so many mistakes have been made along the way that some of it's key tenets are easily debunked, prominent among them, the "multiplier effect."

If you don't know what the multiplier effect is or why it's important, it basically states that any new introduction of money into an economy will result in increased economic production MULTIPLE TIMES the original increase.  This is based on the fact that one person's expenditure is another person's income, so an increase of $1,000 can result in a total economic production of say $5,000.

Bob gets a tax break of $1,000 and buys a new computer from Jim.
Jim takes the money and spends some of it, say $900, buying a new suit from Bill.
Bill takes $800 of that $900 and buys himself a set of tools from Amy

and this cycle continues on and on and on till the fractional expenditure is so small little Leroy is buying a 1 cent piece of bubble gum, resulting in $5,000 in total new spending.

While this explains the multiplier effect, it does not, however, explain the political motivation behind it and why (leftist) politicians love it.  The multiplier effect basically authorizes or legitimizes increased government spending, especially deficit spending because that $100 billion in welfare to the poor, or that $10 billion forgivable government loan to Solyndra will result in MULTIPLE times that amount in economic growth, and therefore tax revenue.  This is why Nancy Pelosi foolishly said unemployment and government checks was the best thing for the then-economy, why Paul Krugman believes in aliens, and why nearly every leftist is for increasing government spending on the parasitic - it not only wins them votes, adoration, and popularity among the sheeple, but the multiplier effect is quite literally magic economics with no costs because in theory it generates more tax revenue than it costs.

Now, you don't have to be an economist to know something is fishy when politicians and pundits start claiming there's such a thing as a free economic lunch and you can have something for nothing.  And so to debunk this malarkey we can simply look at whether or not increased government spending has resulted in economic growth in the past.  And the truth is, it hasn't.  It simply hasn't.  Not only has government spending coincided with slowing economic growth, the Obama presidency was a Keynesian wet dream come true that has only further proven the multiplier effect just does not work.  Obama doubled the national deficit, spending an additional $10 trillion the country simply didn't have, and GDP continued to limp along at a pathetic 2.2% average growth rate.  I only need further point out if there was a Multiplier Effect, we wouldn't have to be running deficits...which we most certainly have the past decade.

In short, to those of us living in the real world, the multiplier effect simply doesn't work.

But while anybody (if they're so inclined) can look up the data on the FRED database and prove it to themselves, it's more important, especially in an attempt to educate the public, to explain WHY the multiplier effect doesn't work and why economic policy based on it is doomed to fail.  And that answer comes in way before the government check is cut, the tax break given, and Bob pays Bill $1,000.  Specifically...

where did the money come from?

If you look at the multiplier effect, it is truly magical because it assumes we have this pile of money that just "POOF!" shows up out of thin air when the economy conveniently needs it.  But, again, any adult who has lived in the real world knows there is no such thing as a free lunch.  The money has to come from somewhere, so where?

There are several sources, but regardless of the source they are all "other people's money."  And it is here economists and politicians conveniently forget this fact because for every penny of economic growth you garnered by giving Bob $1,000, it is obsoleted from the lack of economic growth that didn't happen because you took that $1,000 from Bill.

Say you increase taxes on "the hated rich."  You do this because it's popular, you want to get re-elected, and you believe in Santa Claus the multiplier effect.  Congratulations, you managed to take $10 bill from rich people and give it to poor people.  Now instead of yachts, champagne, and caviar, that money will be spent on rims, trailer park fences, and antibiotic STD treatments.  You didn't create any new economic growth, you merely shifted it.  Worse, (though Keynesians will knee-jerk to quickly point out poor people are more likely to spend money) congratulations!  You increased SPENDING, NOT INVESTMENT!  Nobody ever points out it is rich people who are more likely to invest their excess reserves, which leads to....

jobs and GENUINE economic growth.

Buying rims doesn't lead to long term economic growth.  Paying for day care for your bastard baby daddy children does not increase the economy's economic growth potential.  But building a new plant or creating a new business DOES create jobs, DOES increase our economic growth capacity, and DOES improve long term, sustainable economic standards of living. But in the world of Keynesians they do not differentiate.  Blowing $400 on grills for your teeth or tattoo sleeves for your arms is just as viable economic "growth" as investing in a new semiconductor plant.

Second, let's just agree with leftists/Keynesians and say rich people don't spend their money as much as the poor.  And that money would "just sit in the bank anyway."  Well, do banks just let money sit in their vaults collecting dust?  No, of course not.  They lend it out so people can buy things, but also invest be it a house, an education, or a company, all of which leads to more than just mere "consumption" and "spending."  Additionally, taxing people with money simply because "it would just sit in the bank" leaves them with less money to put into the bank.  This lowers the supply of lendable dollars which increases interest rates and lowers economic growth.

And third, perhaps more pertinent to today's economy, would be the closest we can get to "economic magic" where the federal reserve just prints off money.  These monies are infused into the economy either through government programs, bank bail outs, or (as I soon predict will happen) student loan bail outs, and will all be heralded by leftist politicians as "investments."  This simply causes inflation, taking away real economic growth from the economy by lowering the purchasing power of every one else to bail out the banks, hipsters, liberal arts majors, or lazy and stupid people who just can't keep their legs shut.  This has happened in Argentina, Brazil, the Weimar Republic, and any other country that has tried to print their way to success, and the only reason it hasn't happened in the US YET is because we have the world's reserve currency (which is an entirely other topic).

We could go on citing different examples, but whatever the source of the original "seed money" to get the multiplier effect going, there is an equal and opposite economic effect because you simply took money out of another part of economy and overall economic growth will remain unchanged.

The truth is economic growth is caused by hard work, innovation, creativity, self-supportation, and increased efficiency.  It's nothing new or mysterious as human kind has, through trial and error (and not faux "studies" done by idiots in the economic departments of academia or Washington) figured this out over the millennia.  And the fact something as stupid as "the multiplier" effect can not only be swallowed, but be so prominent among economist and professional circles, is more a testament to the human mind's amazing ability to lie to itself than any kind of epiphany or "discovery" by the "profession" of economics.  It is here I simply ask Americans and westerners to do something they pride themselves off of.  Be TRULY independent minded people with genuine critical thinking skills.  Wake the F up, use your brain, think things through and realize just what a bunch of frauds, posers, and charlatans most economists and politicians are.
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Kristophr said...

The multiplier effect works ... but it also works in the opposite direction.

Each dollar collected in tax and pissed away by the government does hundreds, if not thousands of dollars of damage to the economy, increasing expenses for goods all the way down the line.

That stolen dollar no longer drives the economy in any truly productive way, it merely becomes hurricane damage, at best, or an economic detriment that pisses even more dollars away, at worst.

Take The Red Pill said...

This "multiplier effect" sounds like something from a 'Cargo Cult', akin to "magic dirt".

PoCoTex said...

Remember the pursuit of "perpetual motion" machines?

I contend that the "multiplier effect" is simply a financial "perpetual motion" machine.

The people attempting to develop "perpetual motion" machines neglected one factor: friction.

Anonymous said...

Thank you! I was wondering, the whole lecture in macroeconomics, why the multiplier effect mysteriously disappears when you are talking about taxes rather than spending.

Another malicious effect of this whole philosophy is that it causes Keynsian economists and the politicians they advise to go to war with savings. People saving that "free money" instead of immediately spending it reduces the multiplier, the idiocy goes, so we must induce them not to save. (Nevermind what banks actually do, and nevermind why people try to save when they *can*.) Without savings, every minor hiccup in life becomes a disaster. (Instead of hitting their savings/checking account for a $500 annoyance, poor people are heading to the title loan office.) Without reserves, every busy day at a bank becomes a potential liquidity crisis, and all the federal reserve does is tie them all together (conservative and risky alike) so that they all fail *AT THE SAME TIME*. Inventory taxes means that industrial concerns cannot stockpile parts, stores cannot stockpile goods (or are punished if they do), and so everything must tick along like clockwork or grind to a halt at the first hangup in the supply chain.

FSK said...

The money multiplier effect comes from fractional reserve banking.

With a 10x reserve ratio, each $1 of new cash leads to $10 in the economy, due to fractional reserves.

It's actually a bad thing. It means that, when the government has $1 in deficit spending, the banking industry gets to create $9 via fractional reserve banking. So the beneficiaries of inflation are private sector banks more than the government.

Steve D said...

'the multiplier effect simply doesn't work'

If it did, we would have unlimited wealth.

Anonymous said...

Ιnteresting point of view/analysis... However as FSK mentioned above... your analysis implies a zero-sum game of economics.. which is at least inaccuarate.

How would you rephrase your analysis if the 1000$ tax break given by govermennt to Bob.. was actually a loan the goverment took from the money markets (at usually bargain rate given the fact that goverments are generally considered AAA debtors). Then the multiplier effect would increase the goverments tax income way more than the amount it would cost it to pay interest on the loan it took to finance the tax break. And given the fact that goverment debt makes up the basis of the money supply in the system... It is by its very nature NOT supposed to be payied back... but to be refinanced indefinatly.

Barring any inflationary pressures this sceme would put on socieaty.. is there any other factor that might make the sceme to fail?

Kristophr said...

Anonymous: Yes, that "loan" disrupts lending. Instead of money being lent for investment or infrastructure purposes ( anything from opening a new factory, to someone building a home, or buying a car to go to work ), the money gets pissed away by someone who did nothing to earn it.

This causes damage, as the leach is now competing for goods with productive persons.

And dismissing inflation the major bad that it is, show your ignorance. Inflation is a pernicious tax on savers and investors, and causes incredible damage.

In 1963, a soda jerk might earn five 90% silver quarters ( $1.25 ) in an hour. Those quarters are worth $19 dollars today as junk silver, and it is no coincidence that $1.25 in 1963 would buy you goods worth about $19 dollars today.

You have no bloody clue how badly inflation hurts everyone except the leaches that get to spend the fiat created dollars first.

Anonymous said...

The Addition Effect:

1) Introduce a quantity of cheap energy to the economy and you will get a quantity of goods and services produced.

2) Repeat for more goods and services produced

3) Trump's plan to eliminate the fetters against fossil fuels will certainly help boost the economy

4) The USA holds 4,000 Billion barrels of shale oil, 16 times more than Saudi Arabia.

Print oil, not money, and your economy will boost.

Imagine how strong the US economy would be if we would pay 25 cents a gallon. That is possible if you build more refineries.

It's not a multiplier effect, but you can add as much as you want. 4,000 Billion barrels !

Really, the US economy needs to be high on cheap energy. If you want to boost the US economy, drown it in cheap energy.

Darin Johnson said...

I find that a good way to evaluate this king of thing is to switch from dollars to "stuff." If your theory doesn't work as well in terms of apples and bicycles as it does in terms of dollars, I'm highly suspect. (Exceptions might be pure liquidity issues.)

New money does nothing to increase the number of Nintendo Playstations produced, so it can't actually increase consumption. (An exception might be on the short term, when companies mistake an inflationary increase in price for an increase in demand.)