Sunday, March 08, 2009

Is Macroeconomics Really True?

When the economy is down, people always say that it’s the time when it needs the governmental expenditure like tax cut or large public programs. This discussion is based on "the theory of multiplier effect".

However, is there really a multiplier effect?

Ono Yoshiyasu of Osaka University says an interesting thing, "there's no multiplier effect in the world": An increase in government purchases leads to an even greater increase in income,…the ratio is called the government-purchases multiplier. Mankiw (2003), pp262.

It doesn't look at what the government purchases are, but how much dollars are paid for the government purchases.It says that building a large pyramid and beginning a war is more effective on demand than letting the unemployed do nothing with unemployment insurance.

Is that true? No!!!

(1)Illegal parking

If the government hires the unemployed as a parking guardian, it pays wages to them and in result there's no increase in demand because the wages would be the same as the unemployment insurance paid to them if they weren't hired as a parking guardian. The difference is a decrease in illegal parking in the street.

From the viewpoint of government budget, the government just transfers money from one to the other group of people in the nation. Neither increase in demand nor stimulus to demand.

A balanced budget has no effect on people's consumption and income. A balanced budget multiplier is said to be 1, and there's no increase in income and demand.

(2)Numerical example

Assume GDP is $500 and the government collects $50 from people as a tax and builds a large pyramid for the $50. In this case, the government hires them and the national income is now counted as $550.

However, the people paid the tax of $50 to the government and were just paid back $50 for the construction of large pyramid; they never became wealthy.

A debt-financed government purchases has no effect on income and demand either because people know that today's government purchases should be tomorrow's tax increase.

(3)Summing up

In every case there's no multiplier effect on the economy; the effect of the government purchases on income and demand, which is based on Keynes's theory, is a seeming increase in income in the national income account, but not a real increase in income in the real economy.

However, at the time of recession, some people are unemployed and it would be worth while the government hiring them to do some large public projects because the government projects are valuable in the economy.

The resources (goods and labor services) aren't used well at the time of recession and the government could lose nothing when it used such resources even though the cost was very high.The above opinion seems reasonable to me, but somewhat different from what many textbooks of macroeconomics tell us. What do you think of this discussion?


(1) Mankiw, N. Gregory (2003), macroeconomics, 5th edition, worth publishers,

(2) Ono, Yoshiyasu (2006), logically paradoxical "multiplier effect", Nihon-Keizai-Shimbun (only Japanese)

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