The Multiplier, a theoretical concept invented by John Maynard Keynes in the 1930s

The most fundamental concept in the whole of macroeconomics. The “multiplier” measures the eventual impact on the economy as a whole, GDP, of a sustained increase or decrease in public spending. An increase in such expenditure brings more people into work, they in turn will have more to spend, the companies whose products they buy will have more revenue, and will employ even more people. The initial impact is multiplied through the economy.  Paul Ormerod, an economist at Volterra Partners

Sounds simple, but what is that number? Economists cannot agree on that. The multiplier works both ways. If it is large, the economy will decrease substantially if GDP decreases, or increase substantially when GDP increases.  Most economists believe that figure is pretty small, but IMF chief economist Olivier Blanchard and his colleague Daniel Leigh published an IMF working paper on the size of the fiscal multiplier, according to Paul Ormerod, trying to prove that the multiplier is rather large.

So a fiscal contraction, the basis of the chancellor’s policies, will lead to a sharp reduction in GDP. Events have shown this to be wrong.  Paul Ormerod The IMF duo approvingly cited other estimates, derived from the exotically named dynamic stochastic general equilibrium (DSGE) models, that the multiplier is large. These models have been all the rage in both top academic circles and central banks. Blanchard eulogised them in a MIT discussion paper published three weeks before the collapse of Lehman Brothers in September 2008. “Great progress had been made with DSGE models in understanding how the economy really worked. The state of macroeconomics, he declared, was good (according to Oliver Blanchard in this publication).”  Paul Ormerod

My point is, that in my research, National debt is not all about economic models. Even the IMF cannot predict the economy! I did find it interesting, that the recession really did not affect GDP by that much, and that companies adjusted their production and seemingly, easily survived for the most part. It were the people who lost jobs and homes (7,000,000 of them!)

An inescapable problem for these highly mathematical models is that they do not take into account sentiment, the narrative which emerges around policy changes. Osborne’s fiscal contraction has gradually created a positive narrative across companies, so they are willing to create jobs and invest. Psychology rather than hardline math is needed to tell us what the multiplier really is in any particular situation.      Paul Ormerod is an economist at Volterra Partners, a visiting professor at the UCL Centre for Decision Making Uncertainty, and author of Positive Linking: How Networks Can Revolutionize the World.



3 thoughts on “The Multiplier, a theoretical concept invented by John Maynard Keynes in the 1930s

  1. My answer to the question : It is hard to cut taxes with high National debt. Monetary policy can only go so far in helping economic growth. In order to keep the interest cost of carry the National Debt, bond yields are too low so retired people don’t have enough income to pay their bills, investment returns for retirement savings plan will be lower and workers will have to either save more or work longer.

  2. Thanks Rico for that insight 🙂

  3. Pingback: Five Cultures Later | What can we do about national debt?

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